The balance of power between the Centre and states under India’s constitutional federalism, historically fraught yet resilient, has been tilting towards greater centralization ever since the Bharatiya Janata Party (BJP)-led government came to office in 2014.
This belief gains ground when reading the final report submitted by the 16th Finance Commission (FC), a body that India’s Constitution mandates be set up every five years to decide how taxes collected by the Centre should be shared with the states and between states.
The 16th FC report is the latest in a long list of examples where existing systems have been upended in an attempt to centralize powers in Delhi. The recent fiasco over examination testing has revealed glaring capacity gaps at the National Testing Agency, a government body that was hurriedly set up to centralize entrance exams.
Another example is of party faithfuls appointed as governors in various non-BJP ruled states found trying to disrupt democratic processes. States have been complaining of how the introduction of the goods and services tax has visibly eroded their fiscal autonomy. The list is long and the 16th FC report reinforces that trend.
The constitutional mandate to set up an FC every five years was the direct result of a grand bargain: the Constituent Assembly’s decision to vest the Centre with extraordinary powers at the republic’s birth was sought to be tempered with a distinctive federalism design that allowed sharing of some powers between the Centre and states; fiscal federalism was a critical part of this design.
The 16th FC report and its recommendations on how states are to be funded for the next five years go to extraordinary lengths to pedal back on this grand design and provide the centralization project a helping hand.
At its core is a decision to keep the overall devolution ratio—a percentage of the tax from the central ‘divisible’ pool that the Centre has to share with states—for the next five years unchanged from the previous five year’s 41%. It reflects the commission’s tightfisted attitude towards states while cutting the Centre a lot of slack. This is manifest in two ways.
One, the ‘divisible pool’ is arrived at after netting cesses and surcharges as well as tax administration costs from gross tax revenue. The FC admits that cesses and surcharges have been shrinking the divisible pool for the past decade-and-a-half: from an average of 89.2% during the 13th FC’s span to 82.1% under the 14th FC’s and then to 78.3% under the 15th FC’s.
While the Constitution does constrain the sharing of cesses and surcharges with states, the 16th FC passed up an opportunity to rectify a structural flaw by compensating states with additional funds for the next five years. The excuse used is that the Centre’s need for additional capital spending on defence and infrastructure deserved primacy over the need of states for capital or revenue spending.
Worse, the 16th FC has decided not to recommend any revenue deficit grants (to bridge gaps between expenditure and revenue), a crucial source of funding for states for over 70 years. In the absence of these grants, which are constitutional in nature and allow states some autonomy on spending, discretionary and conditional grants from the Centre automatically gain the upper hand. These non-FC grants have been growing apace (see chart).
The 16th FC, thus, through lower tax devolution and its elimination of constitutional grants, has empowered the Centre to have a larger say in states’ affairs.
The 16th FC has also gone around the states and allocated ₹791,493 crore of grants directly to rural and urban local bodies. It is well accepted that the third tier needs funds to fulfil its governance objectives, but the new grants have multiple strings attached, impervious to locational and social constraints. The FC’s attempts to strengthen the Centre’s hands in controlling the fate of local bodies, by skirting states, is fairly evident here.
Volume-I of the FC report (featuring recommendations) uses the word ‘efficiency’ 101 times, mostly in relation to state finances. There is a reason for an obsession with the word: “This Commission has taken the view that, considering India’s growth imperative, there is a need for at least a small shift in the devolution criteria towards efficiency.”
Beyond the fallacious nature of its argument, the statement is oblivious to how a fixation with economic efficiency could lead to narrow gains.
To paraphrase from an interview that Nobel laureate Amartya Sen gave in 1989 (rb.gy/vh8tmq), by focusing uniquely on efficiency, members of the 16th FC may have tried to demonstrate their virtuosity with just one ball when they should have tried to juggle multiple balls, even if a bit clumsily.
The report’s language pits Indian states against the Centre; its tone and tenor are sensitive to the Centre’s concerns but dismissive of states’ anxieties.
The 16th FC talks down to the states about their fiscal indiscipline, but glosses over the Centre’s transgressions. It tends to be preachy, exhorting states to aim for higher efficiency in tax collection and expenditure norms.
This sermonizing tone, though, is largely missing in the Centre’s case, as is any discussion of its economic mismanagement or sluggish tax growth.
In short, the 16th Finance Commission’s report has diminished fiscal federalism in India, instead of enhancing or strengthening it.
The author is a senior journalist and author of ‘Slip, Stitch and Stumble: The Untold Story of India’s Financial Sector Reforms’ @rajrishisinghal