New Delhi: The Congress-led United Progressive Alliance (UPA) has, taking advantage of the political space provided by the 13th Finance Commission (TFC), set the stage for pressing ahead with long-awaited economic reforms, even as it defines a new model of fiscal federalism in Budget 2010.
The recommendations of TFC, chaired by Vijay Kelkar, seem to recognize that India’s ability to realize its potential could be derailed due to the vagaries of internal challenges flowing from a mismanagement of domestic strife, regional inequalities and the environment on the one hand, and external threats, both economic as well as political, on the other.
Reforms push: A view of North Block. The 13th Finance Commission has set out a blueprint for fiscal reforms that makes it imperative that the Centre lay down a transparent fiscal policy road map for three years. Ramesh Pathania / Mint
Its solution to these is a blueprint that envisages a speedy return to high growth that is eco-friendly and inclusive; lays out a pragmatic timetable for achieving transparent fiscal reforms and implementation of a single goods and services tax (GST) by 2014; specifies new measures and incentives for deepening of institutions and economically empowering local administrative bodies; and sets aside substantially more resources for the long neglected north-eastern states that face a constant threat from an increasingly belligerent China.
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While the action taken report (ATR) submitted to Parliament indicates that the UPA has made the best of the opportunity, it does indicate that the government has preferred not to go the full distance, at least for now, on the vexing proposals pertaining to revenue and expenditure reform. A final verdict on the UPA’s political commitment to reforms will have to await presentation of Budget 2010 on Friday.
A seminal document
There is no denying the fact that TFC has served up a game changer. The history of modern India is replete with examples of policy documents that have reset the economic and political discourse in the country. The Second Five-year Plan spurred industrialization with its emphasis on heavy industry and self-reliance; the Fifth Five-year Plan, influenced by Sukhamoy Chakravarty, resolved that growth and equity were not contradictory development strategies; the Sixth Five-year Plan evolved the country’s economic reform strategy and prepared India for the big push—a process that the duo of Narasimha Rao and Manmohan Singh accelerated in unprecedented fashion in 1991. TFC, by the dint of its recommendations, has come up with another similar effort.
New devolution formula
Deciding the devolution of resources between the Centre and the states on the one hand, and then among states, on the other—what economic jargon describes as vertical and horizontal distribution—has always been a tricky issue, especially when it comes to appeasing the various stakeholders.
At the aggregate level, TFC has upped the share of the states in the divisible pool of revenue from 30.5% to 32%—a marginal increase as far as states are concerned. At the same time, it has added around 2.5% (the proportion varies annually) that will go to the so-called third-tier of government (local administrations such as panchayats). This will, in the long term, redefine the political relationship between the states and panchayats and urban local bodies. Effectively, this move makes the devolution share around 34.5%—the highest since the 10th Finance Commission decided to pool all revenues.
Photo by Vipin Kumar/HT; graphic by Paras Jain/Mint
What will make the Centre unhappy, however, is TFC’s clear pointer towards substantially expanding the divisible pool of revenues in the immediate future. It has rapped the Centre on the knuckles for its pernicious practice of increasingly utilizing cesses and surcharges, which do not have be shared with states— these went up from 3.51% of gross tax revenues in 2001-02 to 13.6% in 2009-10—and has put down that this be subsumed within the GST framework. It has justified this on the grounds that the Centre is seeing a markedly higher revenue buoyancy than that experienced by states and believes that this trend would be sustained.
A new federal structure
While TFC has stuck to the conventional maxim of allocating more resources to poorer states, it has ensured that those with the lowest per capita income receive the largest increase. The measures, since accepted by the UPA, also inject a, sense of competitiveness in the grants that will be given to states for implementation of institutional reforms such as the setting up of a water authority to decide user rates and creation of an independent property evaluation board. The states that fail to adhere to their commitments will lose out and the entire pool will be shared among those that perform.
It is, however, the new dimension that TFC has introduced in the federal structure that is bound to impact polity in the long term. Empowering of the third tier, may, if the move works as it should, serve as a percussor to the creation of more states, especially since state governments have always been loath to share power.
TFC has, despite the restrictions of the Constitution, ensured devolution of resources to the third tier as an entitlement. While this will still accrue as grants, it has been linked to the Centre’s divisible tax pool in the preceding year; 1.5% of gross tax revenues will be automatically transferred and the balance 1% only if the third tier is willing to undertake institutional reforms. In absolute terms the transfer of resources to the third tier have almost gone up little under four times—to Rs87,000 crore as compared with the 12th Finance Commission’s award of Rs25,000 crore.
TFC has also set out a blueprint for fiscal reforms that makes it imperative on the Centre to lay down a transparent road map on its fiscal policy for three years. It has done away with the “one size fits all” approach and charted out individual fiscal consolidation road maps for states. To ensure that both the Centre and the states stick to their commitments on this front, it has recommended and the government?has accepted, the setting up of an independent monitoring authority.
Alongside, it has backed a single GST that can be implemented in a phased manner till 2014; this will be based on a contractual agreement between the Centre and the states and include a Rs50,000 crore safety net cum incentive package.
TFC has, uncharacteristically, shied away from specifying any road map on its own to tame subsidies. The government in its ATR has for the moment deferred any action on revenue and expenditure reform, even though it has proceeded with the reworking of the fertilizer subsidy regime.
TFC has sought to take head on the concern of regional growth inequalities. It has done so by tweaking the formula for revenue sharing towards weaker states, setting aside, for the first time, special allocations for border districts and adjusting the grants to reward states deficient in education infrastructure and states with large tribal population. By opposing the Centre’s practice of employing cesses, which are not shared with states, to raise tax revenues it has emphasized a more equitable sharing of resources.
At the aggregate level it has, by pushing for fiscal consolidation and targeting regressive subsidies, made a strong case for inclusiveness. By setting out a trade off between fresh public investments and subsidies, it has provided the political justification for tackling subsidies.
In the final analysis it is evident that TFC has set the stage for game-changing reforms, of fiscal and federal nature. The UPA has seized the opportunity by accepting most of the recommendations.
Budget 2010 will be the first signal to ascertain the timetable for its implementation.