Come November, the Fifteenth Finance Commission will redefine the rules for revenue sharing between the union and the state governments. Ahead of this, a new paper by M Govinda Rao of the Takshashila Institution suggests that the existing system of transfers, prescribed by the Fourteenth Finance Commission, has not helped India’s poorer states.

He reveals that, although per capita transfers have been higher to poorer states, they have not been enough to make up for the inadequacy in revenue collection capacity of such states and these states still lag behind richer states when it comes to meeting social expenditure needs.

According to Rao, the Fourteenth Finance Commission changed the architecture for center-state transfers and, in particular, he distinguishes between two types of transfers: general purpose and specific purpose. General purpose transfers, which are prescribed by the Finance Commission, allow states to provide comparable levels of public services at comparable tax rates. However, given the large variations in revenue-raising capacity across states, general purpose transfers cannot fully offset the differences in taxes raised across India. This results in richer states being able to spend more on economic and social services.

In this context, specific purpose transfers, which are provided by central ministries as transfers for certain schemes, become critical in allowing states to provide a minimum standard of public services. Rao, though, highlights several issues with special purpose transfers. For instance, grants are not linked to a shortfall in the chosen services so the educationally backward states do not get larger grants for education and states with the lowest health standards do not get higher per capita grants for health. In addition, there are several schemes with multiple objectives and this means limited resources are spread more thinly without much impact on service levels in the recipient states.

Also read: Redesigning the Fiscal Transfer System in India

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