Share of unconditional transfers has jumped, but remains shy of what it was in 2005-06
The recommendation of the 14th Finance Commission to transfer 42% of Union taxes to states has been projected as a big boost to fiscal autonomy of states, marking a historical shift in the financial relations between the Centre and states.
But is this really a historic move? A Mint analysis shows that while there has been a sharp jump in the ratio of unconditional transfers to states, it still falls short of what it was a decade ago.
The fund transfers from Union to state governments are either tied (conditional) or untied (unconditional). Tied transfers indicate that the Union government exercises tight control over how these funds are used by the states, whereas untied funds can be used by the state government as it deems fit. It is because the 14th Finance Commission has recommended a sharp increase in the share of untied funds, that its decision has been welcomed.
Besides the several categories under which it happens, what makes fund transfer far more complex is that certain funds lie between being entirely tied and entirely untied. However, for the sake of this analysis, the funds have been considered as either wholly tied or wholly untied.
The table below clarifies the categorization of funds, including the heads under which they take place.
The famous figure of 42%, which has caught everyone’s attention, refers to the share of states in the ‘divisible pool’ of Union taxes. The divisible pool is the part of Union taxes that has to be shared with the states. The share of the divisible pool in overall national taxes has hovered around 87% in the past five years. In absolute terms, in 2015-16, the states will get a total of ₹ 5.24 trillion in tax devolution. Besides the tax devolution, other forms of untied transfers amount to ₹ 88,900 crore, taking the share of untied transfers in net transfers to 74%, a surge of 12 percentage points over last year’s budget. The net transfers amount to 6% of GDP.
The highlight of this year’s budget is the jump in share of untied transfers, which is the key to increased fiscal autonomy of states.
However, despite the big jump, this move is only an attempt to restore things to how they were before 2006-07, the year in which the Union government started to channel a substantial amount of funds through so-called direct transfers. These direct transfers introduced by the first United Progressive Alliance (UPA) government to implement centrally sponsored schemes such as the Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS) left very little discretionary power for the states.
As the chart shows, the share of unconditional or untied transfers declined sharply in 2006-07.
In 2005-06, 78% of all transfers were unconditional in nature. This number fell to 65% the following year, on account of introduction of tied direct transfers. There was yet another collapse in share of untied transfers to 57%, when UPA-II, emboldened by its electoral victory, announced its first budget in 2009-10. That budget saw near-doubling of funds under direct transfers, to ₹ 96,000 crore.
The direct transfers were scrapped entirely by the first budget of the Narendra Modi government, and made part of plan transfers. Though this move did not impact the share of untied funds, it certainly provided a boost to the cause of transparency. These funds, to the tune of ₹ 1.4 trillion in 2013-14, were subject to poor regulatory oversight and lax standards of accounting. In several reports tabled in Parliament, the comptroller and auditor general had raised red flags about this issue, even as the share of direct transfers kept growing rapidly. The National Rural Health Mission scam in Uttar Pradesh, during Mayawati’s tenure as chief minister stands as an exemplar of the peril of direct transfers.