Home >Opinion >Online-views >Reaction to the report of the 14th Finance Commission

The standout recommendation of the 14th Finance Commission (FFC) is its recommendation that the share of states in the tax revenues of the central government (net of collection costs as always) be raised from 32% to 42%. I personally find this a most refreshing change from the risk-averse approach adopted by finance commissions in the past, whereby they balked at making any radical changes to the historically trodden path.

Aversion of finance commissions to recommending any dramatic change results from what otherwise is a most laudable convention—whereby governments of the day at the centre have accepted the core recommendations of finance commissions without any alteration whatever. This then has made every finance commission fearful that too radical a departure from the past might give them the dubious distinction of being the first to have their recommendations set aside.

Room for the 10 percentage point increase has been purchased by not prescribing as many grants as previously. Some grant provisions have however been retained, such as to local governments for example, and also for revenue deficit grants. These are absolutes, and so will have to be summed to the absolute equivalent of the 42% tax share provision to obtain the overall percentage provision, for comparison with previous finance commission provisions. My sense is that when that is done, the increase in the overall statutory provision will ramp up from about 38% to 45%.

That is still a big increase, and clearly can be accommodated only by folding in other non-statutory transfers that have hitherto gone to states as a part of Plan flows. The issue of which of these will be folded in has been left to the centre’s discretion, but from the expressed discomfort of the dissenting member in his note, he fears that Normal Central Assistance (which is subordinated to the Gadgil-Mukherjee formula), the Backward Region Grants Fund (BRGF), and the Rashtriya Kisan Vikas Yojana (RKVY), will be among those folded into the 42%.

Until we know the full extent of the fold-in, the net impact of the increase in statutory flows to any individual state cannot be determined from its formulaic share within the FFC provisions, since what each has lost from the fold-in will have to be factored in. In general, I am in favour of streamlining flows so that there is greater coherence at the level of the receiving state in terms of what it is to receive, and when. But I do agree with the dissent note that there could be huge problems transiting from closed transfer channels to a single consolidated flow. The way governments in India work, it is entirely possible that promising state-level agriculture programmes funded under the Rashtriya Krishi Vikas Yojana (RKVY) might wither and die unless equivalent allocations are quickly made within the state from the single statutory flow.

States at the end of the day are interested in their share of the total, and the formula determining that share. Two changes have been made in this. One is that the problem of staying with the 1971 population census, a vexed resolution of the population control incentive problem, has been ameliorated by bringing in the 2011 census figures in addition, with a weight of 10%, as against 17.5% for the 1971 figures. The other is that the income distance formula used, with a 50% weight, has reverted back to what was used by FC-XII. I regret to say that the report exhibits a failure to understand what FC-XIII did in this regard (para 8.28). Average taxable capacity at a common average tax-to-GDP ratio underlies all formulae using income distance; all that FC-XIII did was to differentiate between the average tax-to-GDP ratios of general and special category states. That shift was done to accommodate the fiscal disadvantage of special category states so that their entitlements would be worked into the devolution formula, rather than be discretionarily dealt with through deficit grants. Now the FFC has had to retain deficit grants to special category states (along with some other general category states with legacy problems), which is an unfortunate vestigial remnant of an earlier and faultier way of dealing with the problem.

States have been held to a targeted fiscal deficit of 3% of their respective gross state domestic product (GSDP), with flexibility to go up to a maximum of 3.5%, if their debt profile permits it. The flexibility is a good feature. Fortunately, the growth rates to be used to determine the borrowing entitlements of states from year to year are to be determined in the manner prescribed by FC-XIII, with respect to achieved past actual rather than a projected rate, so the growth incentive remains preserved within the system.

Table 14.1 sets out the fiscal road map for the federation over the 2015-20 horizon. The amended revenue deficit target for the central government, requiring 2% by 31 March 2015, has been given a happy go-by, and the centre has been permitted to bring down the revenue deficit slowly to 0.93% over five years. Probably a reasonable recognition of that which is feasible, over that which is desirable. The juxtaposition of central fiscal and revenue deficit targets does not leave a lot of room for capital expenditure by the centre, which will cross 2% of GDP only in 2019-20. But then again, the centre can always generate supplementary funding for capital expenditure from disinvestment. The report says nothing at all about that possibility.

There are many things left unaddressed by the report, such as issues of transparency in budgetary documentation of the kind addressed by FC-XIII. At a time when land is at the forefront of public debate, surely the FC-XIII recommendation that unutilized land holdings (acquired but unused) of governmental bodies (such as the Food Corp. of India) be made public as part of fiscal documentation, needed to be sounded again. Perhaps the FFC considered the matter and thought it lay beyond their remit. Yet, documentary transparency of that kind can lead to resolution of a lot of problems that bedevil growth and development in this country in a systematic and orderly fashion.

Indira Rajaraman is an economist and is currently on the board of directors of the Reserve Bank of India.

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