Later this week, the government will make public the report of the 13th Finance Commission (TFC), almost two months after it was submitted.
In its wisdom, the government has decided to release it the same day as the annual Economic Survey (2009-10) is tabled in Parliament. So, there is a good chance that TFC’s submissions, which had been expected to be a key part of the Union Budget, may be overlooked. All the more so because the Budget—the marquee annual economic policy event—follows the next day on 26 February. It would be a pity if this indeed happens.
The finance commission is a very important element in understanding the political economy of India; it defines a critical part of the economic relationship between the Centre and states on the one hand, and among states on the other, especially in the sharing of resources. A constitutional body, it is set up once every five years, recognizes the changing dynamics of the economy, both with its interactions with the rest of the world and its evolution within, and decides the devolution formula between the Union government and the states. It is, in fact, a unique dispensation among emerging markets and something that has contributed significantly in keeping the country together politically and economically.
The TFC, under the stewardship of Vijay Kelkar, was constituted in 2008, just as the most dramatic upheaval in the global economy had begun to unfold; many believe the meltdown, when it subsides, will have completely redefined the contours and construct of the global economy—resulting in the “new-normal”, as some economists prefer to call it. Coincidentally, the crisis began when the Indian economy itself was in the middle of a very profound transformation that has pushed up the growth trajectory to an entirely new level—averaging 9%-plus in the three years ended 2007-08. It was also on the threshold of ushering in a new era of tax administration, with the introduction of a direct tax code and the single goods and services tax (GST)—both of which will influence the resource share if the promised buoyancy pans out (or doesn’t, as some fear).
The importance of the TFC is, therefore, enhanced not only in economic context, but also in creating the wherewithal to accommodate these exceptional circumstances and striving to ensure that no state is left behind—since the gains in growth have so far been shared unequally, resulting in a huge gulf between the richest and the poorest state in terms of per capita income. The recommendations come into effect for a period of five years beginning 1 April.
We have no clue as to what exactly the TFC has recommended, though, there are enough signals that stem from its terms of reference. It is clear that the Centre is looking forward to the TFC’s recommendations to enforce a new blueprint for fiscal consolidation that will ensure the spurt in growth is sustained and, at the same time, is environment-friendly—the latter would be very important, especially to show to the rest of the world that India is a responsible emerging power with a stake in preserving the environment. Both of these were added, reflecting the medium-term concerns of the Congress-led United Progressive Alliance (UPA).
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This is not surprising. Governments in the past have opted to load the finance commission with their own agenda.
This is most visible with the panels beginning with the 10th Finance Commission that have been constituted in the period coinciding with the most vibrant phase of economic growth.
Take for example fiscal reforms. Since governments inherited the edifice from the past, they would often use them to skilfully transfer the burden of adjustment to states. Earlier, the formula prescribed only the sharing of income tax (including corporate tax) and excise duties. As a result, the focus of tax reforms, reduction in rates and restructuring inevitably concentrated on these levies; and, there was an incentive to keep up high import tariffs, which, in turn, impeded domestic industry. The 10th Finance Commission, chaired by K.C. Pant, broke with this trend by recommending pooling of all revenue streams and removed these perverse incentives.
The same commission also recognized the emergence of the third tier in government, panchayati raj and urban municipal bodies, in the resource share through the system of grants—the Constitution does not permit a direct devolution. It recognized that urban areas would act as magnets as they become the very first beneficiaries of growth and that panchayats, or village councils, would play a crucial role in implementing government’s inclusive strategy—as they are doing with the Mahatma Gandhi National Employment Guarantee Scheme, the country’s largest rural social safety net.
Coming back to the TFC, it is apparent, as reported by Mint on 15 February, that the commission has unequivocally thrown its weight behind the move towards GST and set out a new blueprint for fiscal reform. The TFC has done its job, now the onus will be on the Centre.
In the final analysis, like in the case of GST, it will boil down to whether the UPA is willing to put down political capital to implement TFC’s recommendations. Something tells me that the government will not disappoint us.
Anil Padmanabhan is a deputy managing editor of Mint and writes every week on the intersection of politics and economics. Comments are welcome at firstname.lastname@example.org