Devolution for FY20-21 cut marginally

The Fifteenth Finance Commission (FC), in its report for fiscal year 2020-21, has recommended a marginal reduction in the vertical devolution of the divisible tax pool to 41 per cent from the prevailing 42 per cent.

This is due to the newly formed Union Territories of Jammu and Kashmir, and Ladakh, which will get funds from the Centre’s share, which means devolution will be for 28 states compared to 29 earlier. The FC also reintroduced performance-based incentives to states on two parameters — demographic performance and taxation efforts — and said it would recommend more incentives on further parameters, conditional upon states fulfilling certain criteria in the coming fiscal year.

While presenting her Budget, Finance Minister Nirmala Sitharaman said the Centre had decided to “substantially” accept the recommendations of the 15th FC but did not indicate which recommendations it had accepted.

The 15th FC, whose term was extended for 11 months , will submit its second report — for 2021-22 to 2025-26 — in October.

It stated in its first report that a number of key recommendations it was required to make will be examined in greater detail and will find space in the second report. The includes the feasibility of a separate defence and national security fund, for which it will form an expert group before giving its recommendations.

The report also said that the Centre should, in the coming year, rationalise centrally sponsored schemes and that centre and states should fully reveal the extent of their off-budget borrowings.

“The Commission has noted the tendency of the Union and state governments to borrow outside the Consolidated fund, leading to accumulation of extra-budgetary liabilities. We recommend that in the interest of transparency, both the centre and states need to make full disclosure of extra-budgetary borrowings and take steps to eliminate them in a time-bound manner,” it said.

While the horizontal devolution — the first step in which the Centre sets aside the kitty for the states’ share — was marginally reduced, there was a 21 per cent increase in revenue deficit grants for states from Revised Estimates of 2019-20 (the last year of the 14th Finance Commission award period) to 202021, budget documents show.

In its report, tabled alongside the Union Budget by Finance Minister Nirmala

Sitharaman, the 15th FC said that while it was inclined to leave the vertical devolution unchanged from the 42 per cent recommended by the 14th Finance Commission, it had to take into account the new UTS.

“We notionally estimated that the share of erstwhile state of Jammu and Kashmir would have come to around 0.85 per cent of the divisible pool. We believe there is a strong case to enhance this to 1 per cent to meet the security and other special needs of J&K and Ladakh,” the report stated. “Since this enhancement has to be met from the Union’s resources, we recommend that the aggregate state of shares may be reduced by 1 percentage point to 41 per cent of the divisible pool,” it said.

“This rounding off works marginally in favour of the Centre,” said DK Srivastava, Chief Policy Advisor, EY India.

“By assuming nominal GDP growth rates at 10 per cent for FY20 and 11 per cent for FY21, the Fifteenth Finance Commission has made optimistic assumptions. These marginally optimistic growth assumptions imply an underestimation of Commission’s recommendation for the revenue gap grants,” Srivastava said.

Among other recommendations, the Commission also suggested that the country needs an overarching fiscal framework for Centre as well as states, on the lines of the

FRBM Act, which would lay down accounting, budgeting and auditing standards to be followed at all levels of the government.

“We recommend the constitution of an expert group to draft such a legislation which will be an important first step in establishing a statutory framework to implement the essential features of a sound Public Financial Management System. The group should also clearly identify those aspects of the legislation that will require consistent legislation at the level of the states,” it said.

While making its recommendations, the Commission did not mince words on the economic slowdown and its impact on the centre and states’ resources. The report said that making forecasts for the next five years using 2019-20 as a base will be ‘excessively aspirational and inaccurate’. Conservatism will not help either. Hence, the 15th FC will wait for macroeconomic indicators over the next few quarters to make these forecasts in its next report.

The 15th FC departed in a way from previous commissions by increasing focus on local bodies. “We recommend an amount of ~90,000 crore as grants to local bodies for 2020-21, which is 4.3 per cent of the estimated divisible pool. We have also identified the need to increase the inter se shares for local bodies grants for urban areas as we regard cities as engines of growth.”