The 15th Finance Commission missed its chance to fix imbalances and pre-empt deeper political discontent over federalism
All power in a democracy ultimately belongs to the country’s people. In India, one constitutionally mandated body that is designed to deliver on this promise, in a manner that balances revenue power with expenditure responsibilities, is the Finance Commission (FC). The FC is constituted every five years and its scope is set out each time in a document called the Terms of Reference (ToR). It is received political tradition for the incumbent government to accept the FC’s recommendations once they are tabled.
The 15th Finance Commission started its exercise surrounded by a controversy over its ToR that arose from which measure of population to use (2011 or 1971), the nature of performance incentives to be adopted, and whether a separate fund needed to be set up for defence and internal security (see ‘Need for Balancing the Devolution Scales’, Mint, 16 April 2018). Given the impact of the covid outbreak, it delivered its report in two parts, one referring to the pandemic period 2020-21 and the other to a further five-year span from 2021 to 2026. The 15th FC report is unprecedented in the history of independent India, coming as it does after a major pandemic and being the first one after the imposition of a nationwide goods and services tax (GST). This uniqueness does not appear to have impacted the 15th FC much. Just before the budget was placed before Parliament, it delivered a pedestrian set of recommendations that were made public as per the law.
For starters, the 15th FC devolves 41% of the Centre’s divisible pool of revenues to states. This number is exactly the same as that recommended by the previous FC (with an adjustment for the new status of Jammu and Kashmir as a Union Territory). However, there is material shrinkage in the relative size of the divisible pool because surcharges and cesses, which are not counted in that pool, have increased materially from about 10% of the total pool in 2010 to about 20%. The 15th FC could have recognized this trend and granted a greater share of devolution (of a smaller pie) to states. It did not do so. It has also left unsaid its views on the practice of increasing surcharges and cesses, perhaps preferring discretion to valour.
Recognizing the pandemic’s severity, the 15th FC has increased allocations to health and disaster management. It has proposed the creation of an All India Health Service. It has also suggested to states that their spending on health services be increased to 8% of their respective budgets by 2022. It has proposed spending on technology in higher education and for administrative reforms in the judiciary. All eminently sensible, but along expected lines.
One useful contribution of the 15th FC is the set of conditions it has placed on urban local bodies (ULBs) and Rural Local Bodies (RLBs) to receive some of the funds. In particular, the recommendations incentivize the creation of primary health centres, new cities and shared municipal services. It requires that: 1) states set up State Finance Commissions (SFCs); 2) local bodies make their annual accounts public; and 3) they reform the structure and collection of property taxes. Even though there is an inherent contradiction in setting overall rates based on income distance and population while simultaneously incentivizing reforms, the 15th FC has done a good job on the latter. The incentives are well conceived. However, local bodies must simultaneously build capacity for that reform to become reality.
Yet, the timid ‘don’t rock the boat’ approach of the 15th FC, taken together with creeping cesses and surcharges, has more or less put paid to the idea of “cooperative federalism". For example, the Centre today shares only about 5% ( ₹1.80) of the excise and cess it receives from the approximately ₹32 per litre of diesel it charges above the market price of the global commodity. It is this lopsided sharing that allows West Bengal chief minister Mamata Banerjee to highlight the issue by riding to work on an electric scooter. If you impute the impact of all such central charges, the 41% devolution is revealed to be a mirage. It is closer to 29%. Similarly, the power equation between the states and local bodies is heavily tilted towards the former. Incentive-based devolution to local bodies, while good in theory, will likely exacerbate the problem before delivering on its promise.
The sharp imbalance between the Centre and states, between states and local bodies, and even across states based on inclusiveness criteria like income distance, has the seeds of deep political discontent sown within it. Any FC has the tough job of balancing inclusiveness for poorer states and incentives for states that perform. It is akin to giving rewards to both those who finish the race in the lead and those who are at the back of the pack. Unless FCs are able to take bold and far-reaching decisions that promote devolution and decentralization (required by the 73rd and 74th constitutional amendments), we will see deeper political divisions. Particularly at a time when traditional mechanisms of Centre-state reconciliation like the Inter-State Council have become dormant, this makes for a volatile mix at risk of a spark setting it aflame.