The Union government issued a press release on 29 November announcing the Terms of Reference (ToRs) for the Sixteenth Finance Commission (16th FC).
Curiously, the government did not announce the composition of the 16th FC.
The press release merely stated that ToRs for the 16th FC would be notified in due course. This process marks a major departure from the tradition of constituting the Finance Commissions (FCs) and establishing its ToRs together.
The government has made another significant departure. It tasks the 16th FC to make recommendations on the three standard terms mentioned in Article 280(3) of the Constitution.
The fourth clause – any other matter referred to the FC, which was extensively used in the past – is conspicuously absent.
The Primary Constitutional Task of FCs Has More or Less Been Settled
At the present critical juncture in India’s fiscal federalism, let us examine the role and relevance of the FC.
Determining the share of states in the Union taxes (vertical transfer), grants in aid of states’ revenue, and the measures needed to augment the Consolidated Fund of states to supplement the resources of the Panchayats and Municipalities are the principal tasks of the FCs.
Over the years, the complex arrangement for determining the States’ share in individual Union taxes – income tax, excise duties, etc – from the time, the Constitution came into force has been neatly resolved and standardised.
The 10th FC paved the path for creating a single pool of all sharable Union taxes. The FCs, thereafter, recommended a specific, though increasing, percentage of the share of States in the pool of sharable Union Taxes beginning with a 29% share recommended by the 11th FC. 14th FC raised it to 42%, which was retained by the 15th FC (nominally reduced to 41% to account for the conversion of the State of J&K into UTs).
The FCs adopted varying policies regarding grants in aid to states. Some FCs recommended many; some almost no grant. The 15th FC did away with the grants in aid completely, except for disaster relief. The 16th FC did recommend quite a few; most of which were not accepted by the Union government.
With the abolition of the distinction between plan and non-plan grants in 2015, the government now provides all kinds of grants, without waiting for FC recommendations. The system of disaster relief grants has also become quite a standard formula.
The development of principles and extent of measures for augmenting States’ Consolidated Fund for supplementing resources of the local bodies is still a work-in-progress but there is nothing much FCs can do about it.
FCs Cannot Solve States’ Fiscal Gaps
All FCs carry out one basic exercise elaborately – determination of the normative fiscal needs and normative endowment of fiscal resources- of states – which leads to an assessment of their fiscal gaps, which the FCs then seek to close.
The FCs attempt to close this gap by determining the respective (inter-se or horizontal) share of each State in the Union taxes assigned to the States. The FCs spend enormous time and energy in doing so using many factors –the extent of poverty, population, area, fiscal effort, and so on – and weights.
This elaborate intellectual gymnastic in the end amount to nothing. The share of each state moves up and down in a very narrow range. UP and Bihar have always ended up receiving about 30% or more shares. Rich states like Maharashtra, and Karnataka get far less.
As the horizontal distribution of states’ aggregate share in Union taxes does not close the fiscal gap of many states, the FCs are forced to take another step – recommending revenue deficit grants – to close the remaining gap.
The Northeast and the Himalayan states are fiscally unsustainable. No factor, weight, or any other device leads to horizontal distribution covering their fiscal gap. Similar is the case with some large states, which have become fiscally stressed – Punjab, Andhra Pradesh, West Bengal, etc. 15th FC had to recommend as much as Rs 3 trillion as the post-devolution revenue deficit grant.
No state pays any heed to FCs determination of its fiscal needs, resources and gaps. The states manage their finances as they like – resorting to old pension schemes, freebies, and what not.
The necessity of FCs recommending ever-larger revenue deficit grants to an ever-increasing number of states has become an exercise in futility. It deserves to be simply abandoned.
Let No Finance Commission After 16th FC, Be Set Up Until 2050
India’s fiscal federal architecture has been massively transformed since the Constitution came into force. States' fiscal resources are quite predictable now with a more or less fixed share in Union taxes and their borrowing limits fixed at 3% of their GSDP.
As elaborated above, there is not much the FCs can do in altering the 42% share of states or in determining States’ inter-se share. The FCs don’t, any longer, have to be bothered with the task of recommending grants, including the structure and formula for disaster relief. The post-devolution revenue deficit grants need to be simply given up.
The FCs cannot close the fiscal gaps of the Northeast and Himalayan states; the Union government should find some answer as it has created these fiscally unsustainable states.
In the past, the FCs were tasked with numerous mandates under the 'any other matter referred to'. The FCs recommended many measures for addressing the indebtedness of states, which is no longer the issue. Most recommendations on other matters were simply not acted upon.
In view of this, it is time India considers doing away with the system of setting up a new Finance Commission every five years.
It will be far more advisable if the 16th FC is asked to provide its alternative recommendations for the share of states in Union taxes (which can as well be 42%, including J&K) along with their states’ respective inter-se shares for the period until 2050.
Many FCs have recommended making the FCs permanent. In contrast, the 16th FC may be asked to offer its views on amending the Constitution for a Finance Commission to be set up every 25 years after 2050 and doing away with the clause relating to providing grants-in-aid of revenue for states.
(The author is a former Economic Affairs Secretary and Finance Secretary of India. This is an opinion piece and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for the same.)
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