Equalizing delivery of public services among the states

Equalizing delivery of public services among the states

The core task before all finance commissions is to ensure the capability for roughly equivalent levels of public services to all Indian citizens, regardless of the state of location. The equalization sought is citizen-centric, and calls for compensation across states for differences in fiscal need, modified by cost disabilities. There can be no pretence that this by itself, even if fully and correctly done, will guarantee equalization of delivery on the ground; but statutory transfers to states are clearly a necessary enabling prerequisite.

The 13th Commission has set the aggregate annual share of states at 32% of the divisible tax pool of the Centre for 2010-15, up slightly from the 30.5% set by the 12th Commission. The share of individual states in the total is set, as always, through a transparent formula. The formula is newly configured. The report demonstrates that even states whose percentage share has fallen will nevertheless get a higher transfer as a percentage of their respective domestic product, as a result of the larger aggregate provided for.

Tax shares are supplemented by absolute grants in finance commission provisions. With grants added on, the transfers to states ramp up to 39% of the divisible pool. There are 10 grant categories, some with multiple components. The third largest grant, for Rs50,000 crore, is to compensate states for revenue losses following introduction of the GST (goods and services tax), but heavily conditional on conformity with a nationally uniform single flat-rate model, with a comprehensive tax base that includes real estate transactions.

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If this is adopted, GST will replace the stamp duty levied by states. Despite the three-year interval allowed for implementation, and a few permitted relaxations, the requirements are sufficiently exacting that the grant may not become?payable.?Minus?the?GST grant,?total?transfers?come?down to 38% of the divisible pool.

Over to the states: The report shows that even states whose share of the tax pool has fallen will get a higher transfer as a percentage of their respective domestic product, as a result of the larger aggregate provided for. Pradeep Gaur/Mint

What therefore becomes a matter of critical importance is whether there are enough incentives for fiscal discipline built into the 13th Finance Commission’s provisions and recommendations, so that the good growth prospects are turned into a fiscal correction opportunity.

A very large number of methodological innovations in the report aim at sharpening the incentives for fiscal discipline, better outcomes and spatially dispersed growth; strengthening monitoring and accountability in the system; and restructuring the measure of fiscal need in pursuit of the core task. This is done through design alterations in the formulas underlying transfers to both states and local bodies, the grant conditionalities, and the operational and other features of the fiscal road map recommended for the Centre and states.

The fiscal road map is approached not as a matter of targets and paths alone. There are heavy disclosure obligations placed on the Centre. The recommended measures include giving the medium-term fiscal plan (MTFP) primacy as a statement of commitment rather than a statement of intent, with a detailed break-up by budget head of Plan and non-Plan transfers to states three years into the future. This will render flows to states predictable, and in turn enable medium-term commitments by states.

The revenue consequences of new capital expenditures are also to be quantified, so as to factor in the cost of adequate asset maintenance, going forward. Structural shocks such as pay commission arrears are to be avoided by making the pay award commence from the date of acceptance. The arrears from back-dated pay commission awards were a major cause of fiscal uncertainty among states during 2008-10, as much as the revenue shock resulting from the global slowdown. Additional disclosure requirements from 2013-14 include the listing of all vacant land and buildings, valued at market prices, by all departments and public sector undertakings.

The finance commission has no instruments with which to either incentivize or enforce the fiscal road map recommended for the Centre. However, since the road map was an added term of reference from the Centre, it is hoped that it will be legislated, with the recommended provision for an independent review mechanism, to enable monitoring. Disinvestment proceeds are recommended for inclusion in the fiscal accounts as non-debt capital receipts, and have been conservatively estimated to rise from 0.5% of gross domestic product (GDP) in 2010-11 to 1% in 2014-15.

The projected correction path for the Centre turns the revenue deficit into a surplus of 0.5% of GDP by 2014-15, winds down the fiscal deficit to 3% for that year, and in conjunction with disinvestment proceeds of 1%, makes possible capital expenditure at the Centre of 4.5% of GDP. States are expected in aggregate to achieve a zero revenue deficit (or surplus) by 2014-15, and a fiscal deficit of 2.4% of GDP. For both the Centre and states, 2010-11 is treated as an adjustment year, with options left open for a moderate pace of fiscal exit. Indeed, the permissible deficit limits for 2010-11 in the?Central road map are higher than those projected in the MTFP accompanying the 2009 Union Budget. The consolidated debt of the Centre and states together is expected to fall to 68% of GDP by 2014-15. The paths for individual states are tailored to their initial conditions in a base period before the onset of the global meltdown.

The states are incentivized to enact commitments to the road map as prescribed in the report, with three inducements. These are interest concessions on debt owed to the National Small Savings Funds, waiver of the debt owed to Central ministries other than finance, and the withholding of state-specific grants for failure to enact. They are given a year to do this, so that their fiscal correction horizon starts only in 2011-12.

Enactment carries these incentives, but enforcement of the state paths is left to the Centre through state borrowing caps. A new formula for determining borrowing entitlements replaces actual growth (with data availability lags) in place of projected growth rates. High-growth states will thereby benefit from their performance, and this will also avoid the phenomenon observed in the past of these states being confined to borrowing limits well below their deficit percentage entitlements, by virtue of the use of projected rather than actual growth.

The Central subsidies on food, fertilizer and petroleum are examined in very great detail, and a feasible correction path for each is prescribed. The total subsidy bill is lower by 10% in nominal terms in the terminal year, relative to the budget projections for 2009-10 of around Rs1.11 trillion. The fertilizer subsidy is to be reduced in 2014-15 to one-fifth in nominal terms of its budgeted sum this year. The oil subsidy is brought on-budget, confined to families below the poverty line for liquefied petroleum gas and for kerosene, with a further reduction by 40% through better targeting. The food subsidy, however, is allowed to rise by 40% in nominal terms, given the expected passage of the legislated right to food.

The non-Plan revenue deficit grant is a most unfortunate vestigial remnant of the inherited transfer structure, an embedded invitation to fiscal profligacy by states. Owing in part to the restructuring of the transfer formula, the number of states qualifying has been reduced to eight from the special category.

The provisions for transfers to local bodies mimic the tax shares of states, but are prescribed as absolutes as constitutionally required, with reference to the divisible pool of the previous year. There is a basic grant of 1%, and a performance grant which ramps up the total provision to 2% of the (current) divisible pool. The performance conditionalities strengthen accountability and monitoring at the third tier, improve the efficiency of the state as a pass-through agent, and call for full disclosure of state-local transfers.

The urban share, hitherto roughly half the rural provision in per capita terms, has been raised to parity with the urban population share by the 2001 census. With this, and in conjunction with the three-part environmental grant, it is hoped that the grave water and sanitation conditions, faced by cities no less than rural habitations across the country, will be somewhat mitigated.

The writer is honorary visiting professor at the Indian Statistical Institute, Delhi, and a member of the 13th Finance Commission.

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