In this first part of a two-part blog on Union Budget 2020 and the North Eastern states, we take a closer look at 15th Finance Commission recommendations on devolution of central taxes, and its impact on states’ finances.
The recently announced Union Budget by Finance Minister Nirmala Sitharaman accepted most of the recommendations by the 15th Finance Commission. Tasked with the preparation of a criteria to equitably share union’s shareable tax revenue to the states, the commission’s final formula brings relief to the resource-starved north eastern (NE) states of India.
If the Union Government’s revenue projections hold, together, the NE states would get ₹67,047 crores or 8.55% of the total divisible pool of taxes in FY 2020–21. This is a substantial increase from 7.91% (₹51,893 crores) in 2019–20. Let’s take a look at the recommendations of the Finance Commission that resulted in this increase.
15th Finance Commission: What worked in favour of NE States
The Commission’s recommendations were broadly based on three criteria (Figure 1). Between 14th and 15th Finance Commissions, the indicators and their weights changed, resulting in an increased share for the eight NE states.
Between 1971 and 2011, India’s population increased by a factor of 2.19 times. Around the same period, the population of all NE states except Assam went up by a higher factor. The population of Nagaland, Mizoram, Arunachal Pradesh, Meghalaya, Sikkim, Manipur and Tripura went up by factors of 3.83, 3.31, 2.96, 2.93, 2.91, 2.66, and 2.36 respectively (Figure 2). Therefore, the removal of the 1971 population and substitution with 2011 values benefited NE states.
While the area of the NE states is only 8.583% of the country’s total area, the Commission’s decision to consider 2% as the minimum area of a state, the total share of NE states went up to 16.551%. Thick forest covers, reasonable performances in tax effort and demographic performance also helped NE increase its share.
Arunachal Pradesh is the biggest beneficiary of these changes, as its share went up from 1.37% to 1.76%, followed by Meghalaya, Manipur, Nagaland, Tripura, Mizoram and Sikkim. Assam is the only state to get a reduced share (Figure 3).
Pathways of Support
Given the small size, difficult terrain, and low population of these states, their economies are currently not large enough to support internal resource mobilisation. Therefore, the Central Government provides substantial financial assistance to the north eastern region through its annual budget.
Major sources of income for any state government are tax revenues. With the subsuming of state taxes into Goods and Services Tax (GST), there’s no independent avenue for revenue generation for the states. The small size of the economy already restricts their ability to grow tax collection significantly in a short span of time. Therefore, any substantial investment in health, education and infrastructure would require considerable support from the central government. The major sources of funds are illustrated in Figure 5.
Share of central taxes: States receive State Goods and Services Tax (SGST), a share of Integrated Goods and Services Tax (IGST), GST compensation and a part of union taxes and duties, in proportions decided by the Finance Commission. In 2020–21, NE states will receive 8.55% of the divisible pool or approximately ₹67,000 crore.
Grants from Central Government: Centrally Sponsored Schemes like the Mahatma Gandhi National Rural Employment Guarantee Scheme are important, yet expensive programmes. While most other states have to bear 40% of the schemes’ cost, north eastern states need to spend only 10%, with the remaining 90% of the expenditure being borne by the central government. Separate funds are also allocated for “Special Areas Programmes” and North East Council, the nodal agency for the economic and social development of the region.
Lifeline of North-Eastern States — Share of Taxes and Grant-in-aids
Connected to the Indian mainland by a narrow strip of land, the eight sisters of north-eastern India have had only relatively modest economic progress since joining the Indian Union at various times ranging from 1947 to as late as 1975. Together they account for less than 12% of India’s population, and their total expenditure in 2019–20 ranges from a lowly ₹8,665 crores in Sikkim to a respectable ₹99,419 crores in Assam. To put those numbers into perspective — the central government’s expenditure in 2019–20 is estimated to be over 27 lakh crores!
A substantial portion of the states’ expenditure is therefore met through contributions from the central government (Figure 6). Based on the Budget documents for the financial year 2019–20, we can come to the following conclusions. The total expenditure across all the north eastern states in 2019–20 (BE) was ₹2,08,639 crores, out of which approximately 61% was met through contributions from the central government, and the central Government support varies from 49.3% in Assam to 80.6% in Arunachal Pradesh.
Share of net proceeds of union taxes and duties forms a significant part of north eastern states’ budgets (Figure 7). The devolution, based on the recommendations of the Finance Commission, has been increasing continuously over the years. The amount has risen from ₹17,743 crores in 2012–13 to ₹53,616 crores in 2018–19, representing a rise from 6.16% of the divisible pool to 7.91%.
It is imperative that North-Eastern states invest heavily in health, education and infrastructure. Contributions from the central government, as demonstrated above, play a huge role in it. Laying a strong foundation can help the states to reduce its dependence on fluctuations of union revenue.