Fiscal Federalism or Fiscal Conundrum?
The abolition of Planning Commission, emergence of the Niti Aayog, the realities of the 14th Finance Commission and the Terms of Reference of the 15th Finance Commission have raised several questions than answers regarding devolution of funds to the states.
The history of devolution of funds from Centre to the States is dotted with historic milestones and is evolving from generation to generation. India’s fiscal federalism is at crossroads simply because it can choose either to significantly constrain the fiscal power of states or to follow its path of evolving systems and policy formulation to enhance its federal character.
First questions, first. Is India truly federal in nature? No. India is a ‘Union of States’ and does not adhere to absolute federalism. Part XI of the Indian constitution specifies the distribution of legislative, administrative and executive powers between the Central government and the States of India. Indian Constitution is basically federal in form and is marked by the traditional characteristics of a federal system, namely supremacy of the Constitution, division of power between the Centre and States and existence independent judiciary. The Supreme Court is the ultimate independent authority to declare the Acts of the Centre and States ultra-vires if either of them entrenches the defined powers of each other.
Planning Commission
The Planning Commission was borrowed from the Soviet economic system, when India’s public sector was envisaged to remain dominant and the Indian polity was unanimous in following the principles of socialism. (It does, on paper follow policies of Socialism; across party lines! But that can be reflected upon in another piece)
The Five Year Plans- as they came to be known played in shaping the early economic trajectory of our nation, and helping us achieve the goal of ‘self-reliance’. In the 1990s, post liberalization, the basis of having a Planning Commission started to be questioned. But the Planning Commission did perform the onerous task of devolution of funds from the Centre to States. The Indian system of devolution of resources is a complex exercise, for the simple reason that the process involves collection of revenue/taxes from the States and getting them into the ‘Central pool’ and then devolution of funds back to the States. Planning Commission’s role (specifically the role of the Deputy Chairman of the Planning Commission) becomes extremely important for distribution of these finances. If one scrolls through old PIB (Press Information Bureau) pictures, one will see how often the Chief Ministers of States would call on the Deputy Chairman of the Planning Commission and of course, the Chairman of the Planning Commission- the Prime Minister!
Gadgil Formula
Up to the Third Five Year Plan [1961–66], the allocation of Central Plan Assistance was schematic and no formula was in use. Dhananjay Ramchandra Gadgil, a social scientist and the Deputy Chairman of Planning Commission (1967–71) evolved a set of guidelines for devolution of funds based on population, State’s per capita tax receipts, per capita state income and special problems of individual states. The ‘Gadgil Formula’ was adopted in 1969 for the Fourth Plan (1969–74) & the Fifth Plan (1974–79).
The weightage of per capita income of states was 10% in terms of allocation of resources. Since this was perceived as being weighted in favour of rich states, the formula was modified by raising the weightage of per capita income to 20%. This was called the ‘Revised Gadgil Formula’ which was adopted by the National Development Council in August 1980. It formed the basis of allocation during Sixth Plan (1980–85), Seventh Plan (1985–90) and Annual Plan (AP) 1990–91.
Gadgil-Mukherjee Formula
As the then Deputy Chairman of the Planning Commission, Pranab Mukherjee took into account the various reservations of the state governments and a suitable formula called the ‘Gadgil-Mukherjee Formula’ was evolved. The suggestions made by the Committee were considered by NDC in December 1991, where following a consensus, the ‘Gadgil-Mukherjee’ Formula was adopted. It was made the basis for allocation during Eighth Plan (1992–97) and it has since been in use till the Niti Aayog came to existence
The Constitution does not include any provision for categorisation of any State in India as a Special Category Status (SCS) State. But, recognising that some regions in the country were historically disadvantaged in contrast to others, Central plan assistance to SCS States was granted in the past by the erstwhile Planning Commission, through the ‘Gadgil-Mukherjee’ Formula , wherein 30% of total assistance money was earmarked for the special category states.
The allocation in the ‘Gadgil-Mukherjee’ formula was based on several predefined criteria and a corresponding proportionate weightage thereto. Population was provided 60% weightage, the weightage of Per Capita Income was increased to 25%, Performance Factors which included — Fiscal Management, Tax Effort, National Objectives, Population control, Elimination of Female Illiteracy and so on, carried a weightage of 7.5% and Special Problems which included Hill areas, Tribal Sub-Plan areas, North East Council, Border areas, were accorded a weightage of 7.5%.
Source: Report of the Working Group on State’s Financial Resources For the Twelfth Five Year Plan (2012- 2017) | http://planningcommission.gov.in/aboutus/committee/wrkgrp12/wg_state_finan0106.pdf
Niti Aayog and 14th Finance Commission
Article 280 of the Constitution stipulates that after every five years an independent, quasi-judicial and ad-hoc Finance Commission[1] should be appointed to give recommendations on financial distribution between Centre and the State.
The Government of India is presently implementing the 14th Finance Commission which increased the devolution of funds from Centre to States from 32% (previously) to 42%. This was hailed by policy makers and scholars alike. There are two major criticisms which the 14th Finance Commission faced.
First point of contention — how did the Commission so meticulously arrive at the ‘magic figure’ of 42%? This effectively implied that the Centre is losing its fiscal space. The answer to this contestation lies in the subsuming of the ‘Gadgil-Mukherjee’ formula grants itself, which amounted to 5.5% of the divisible pool in their recommendation. In addition, the 14th Finance Commission avoided giving discretionary sectoral[2] grants including environmental grants amounting to 1.5% of the divisible pool. Thus, the legitimate comparison should be between 39% and 42%. This is the hidden fine print of the grand narrative set by the present policy makers that they did some exceptionally great service to ‘Fiscal Federalism’ by providing additional grants to the States.
Second point of contention is that the Centre cut the number of centrally sponsored schemes (CSS) from 70 to just 27 and also cut contribution in many CSS from 75% to 50%. This effectively means States are getting less as their share of tax revenue, and a pittance for the share of centrally sponsored schemes. This criticism is true.
Terms of Reference of the 15th Finance Commission
Southern India (Karnataka, Andhra Pradesh, Tamil Nadu, Kerala, and the more recently formed Telangana) has developed faster and more holistically than any other region in the country. In terms of contributions to the GDP and federal taxes, the southern states each contribute among the most in the country with the exception of Maharashtra. Southern India, which approximately comprises 20% of the population, contributes a full 30% of India’s tax revenues, and yet is allotted a paltry 18% of funds from the Centre.
The South also delivers 25% of India’s GDP. It is not only an economic bellwether with low unemployment, a high rate of industrialisation and a per capita GDP that is over double that of the Hindi belt, it is also leaps ahead on human development and social indicators.
This has become particularly pertinent recently as the 15th Finance (15th FC) Commission was recently constituted and issued its Terms of Reference (ToR) by the Central Government. Although the Finance Commission is expected to endeavour to balance out the concerns of southern states by either reducing the weightage on the population variable or introducing other variables to arrive at a devolution formula, it still has to operate within the ToR.
To examine this contention of the Southern States, let us rewind to the actual devolution of funds to ALL the States. The Centre seems to be sitting on a bounty of Cess/Taxes/Surcharges of lakhs of crore, but has it actually transferred the promised 42% to the States? The plain and simple answer is — NO. It has not.
None of that bounty is to go to the states, even though there has been a constant demand from states to include Cess and Surcharges into the divisible pool. (Refer Table Below)
[1] PRS Explainer | https://www.prsindia.org/theprsblog/central-transfers-states-role-finance-commission
[2] Financial Express | https://www.financialexpress.com/economy/15th-finance-commission-to-realise-the-goals-under-new-india-2022-here-is-what-centre-must-remember/960819/
So if the Centre has only transferred 33.22% average in the last 6 years as against the promised 42%, to all States, it is not realistic for the 15th Finance Commission to provide any additional resources to the Southern States too. If the stipulated devolution of funds is not being devolved to the entire India, the expectation that Centre will transfer more monies to the kitties of any state would be simply impracticable.
In conclusion, Fiscal conundrum continues in the name of ‘Fiscal Federalism’.
