The 15th Finance Commission tried to keep all stakeholders content after a fiscally challenging year, but existing Centre-state imbalances and inequities among states are unlikely to go away
The 15th Finance Commission (XVFC), like all its predecessors, was faced with the gigantic task of making all stakeholders happy. From protecting fiscal harmony in the Goods and Services Tax era, to coming to the states’ rescue after the pandemic disrupted their account books, the commission had too many boxes to tick. How well did it deliver?
The XVFC’s report, tabled in Parliament on 1 February, lays out a recovery roadmap for states, focusing on grants-based transfers from the Centre more than earlier commissions. Some of them, such as grants for education and health, came in for praise, but have not been explicitly accepted by the Centre. Tax transfers, on their part, may have left some states wanting more. While some recommendations are a welcome reprieve for states’ depleted finances, others may have left some rising inequities in limbo.
At the heart of the finance commission’s mandate is to decide, every five years, how the Centre shares revenues with states having diverse sizes and needs. For 2021-26, the XVFC has set a 41% share for states in the divisible pool of the Centre’s taxes, or the total tax receipts minus cesses and surcharges. This share is roughly similar to the 14th FC period—a 1% drop is only because Jammu and Kashmir is no longer a state. So it is the horizontal devolution formula, or how this 41% is distributed among states, that can leave some wanting more.
Out of an estimated ₹42 trillion worth of taxes to be devolved over the five years, highly populous states of Uttar Pradesh and Bihar will alone command around 28% share due to greater needs. On average, these states will get much more per capita transfers than richer states in the south and west, but less than northeastern states that have even greater needs. The XVFC’s per capita devolution pattern has a wide range of ₹16,000 to ₹4.7 lakh for various states.
This range matters because the makers of the Constitution wanted FCs to address fiscal imbalances among states. But the latest formula gives less weight to income distance, a measure of inter-state disparity, than its predecessors. This could be of worry to poorer states, whose per capita income gap with the richest states has almost tripled over the last two decades.
The revised weightage could mark a trade-off between need-based equity and performance. While reducing the weight for income distance to 45%, the lowest since the 11th FC, the XVFC has also awarded states’ efforts to generate revenues (2.5%).
Significant weightage (12.5%) now goes to demographic performance, or how well states have checked population growth. This was necessary to ensure states that did well didn’t lose out simply because the XVFC was, for the first time, entirely using the 2011 Census instead of the 1971 Census to measure their needs. Yet, some southern states, which were most concerned about the shift, have faced cuts in their shares, Karnataka worst of all.
Haseeb Drabu, a former finance minister of Jammu and Kashmir, said that given the reduced weight of equity-based criteria, the XVFC’s devolution formula was “potentially the least progressive" so far.
The FC tried to bridge this gap by recommending state-specific grants in addition to the devolved taxes. But the Centre hasn’t accepted this recommendation yet, instead promising due consideration. These grants, along with other non-devolution transfers recommended by the XVFC, amount to 19.65% of the total transfers, the highest since the sixth finance commission.
In addition to the inter-state imbalances, sources of vertical imbalance—between the Centre and states—are also creeping in. The Centre is increasingly expanding the pool of revenues available to itself through cesses and surcharges, which states are not entitled to. Even budgeted figures for cesses and surcharges in 2020-21 were close to 20% of gross tax receipts, a sharp jump from 10.4% in FY12. This means the states’ chunk in total tax receipts is in effect declining.
In an interview with Mint last month, XVFC Chairperson N.K. Singh said the increased share of grants was also a way to address this, since checking cesses and surcharges was not in finance commissions’ hands and needed a constitutional amendment.
Part of these grants are for specific sectors such as education and health—recommendations that the Centre has not accepted yet. Instead, the government said it would keep the recommendation in mind while implementing centrally sponsored schemes in these sectors.
This leaves these grants to the Centre’s discretion, which, as the XVFC itself has observed, could burden states with lower fiscal and administrative capacity, given that states also foot some share of funding for such schemes. A 2017 study by M. Govinda Rao, a member of the 14th FC, had found that while general FC transfers tend to have strong equalizing effects between states, the same is not true for funds channelized through centrally sponsored schemes. Rao even termed these grants as a “patronising tool to serve political objectives".
Faced with difficult circumstances, the XVFC did well in coming up with a roadmap for fiscal recovery in the next five years. But given its limited powers, rising fiscal imbalances—both vertical and horizontal—remain unaddressed, challenging the basic premise on which the commission was founded.
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