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The Terms of Reference (TOR) of the 15^th Finance Commission (15^th FC) has met with several criticisms ever since its publication on 27th November 2017. Experts have explicitly expressed concerns about particular provisions in the TOR which are seen as potentially moving against the fiscal autonomy of the states. The final recommendations of the Commission, which will carve out the map of centre-state fiscal relations for the next five fiscal years from 2020, are thus, clearly most awaited. However, while we wait for the report of the Commission to be tabled at the end of November this year, let us look back at a few debated provisions of the TOR and their implications on the fiscal space available to the states.

Consideration on maintaining the higher level of devolution of untied funds to the States

The resource transfer from the Union Government to the states has undergone both quantitative and qualitative changes since 2015-16, following the recommendations of the 14^th FC. On one hand, the states’ share in the divisible pool of Central Taxes has increased from 32% to 42%. On the other hand, there has been a cut in Grants-in-Aid (combining both non-plan and plan grants) from the Centre whereby fewer amounts are now made available to the states for implementing the Centrally Sponsored Schemes and for their own plan expenditures. The effective increase in resources transferred from the Centre to the states has thus been much less (about a 3 percentage point increase from 39% to 42%) instead of the commonly held notion of an exemplary increase.

Even this modest increase in transfers seems to be under threat as the 15^th FC considers “The impact on the fiscal situation of the Union Government...” following the enhanced tax devolution to the states in the 14^th FC period. These untied funds, by way of devolved taxes, are crucial for the states to maintain and expand their spending on various social sectors like health, education, nutrition, etc. based on their specific needs. When looked at from the states’ perspective, while there are substantial inter-sectoral variations across states, on the whole, the data reveals that they have invested in social sectors. However, in the presence of initial uncertainties in the funding scenario coupled with changes in fund sharing patterns and the merger of plan and non-plan budgets, the trajectory of public investment in social sectors has not been consistent across states.

Moreover, they are still in the process of reorienting their fiscal priorities and need more time to make best use of the fiscal autonomy coming their way.

Given this situation, if the present Commission recommends a reversal in the direction of transfers to states, it would have a major impact in shrinking the fiscal space available to the latter which in turn would negatively impact their spending capacities in social sectors.

Binding the States with performance-based narrative

The current TOR talks about creating “measurable performance based incentives” for evaluating the states in a host of areas like expanding their tax net under GST, moving towards the population rate of growth, achieving the targets of the flagship central schemes, etc. While a lot of these indicators fail to recognise the unequal footing that the states have, a particularly contested domain has been the consideration to make transfers to local bodies contingent upon meeting certain performance-based criteria. Such a linkage take away from the fact that such transfers, on their own, constitute a separate core mandate for the FC where there are no implications of performance. Moreover, the inclusion of this under the ambit of incentives reverses the efforts made by the 13^th FC to link local grants to the divisible pool and thereby ensure greater fiscal autonomy to local bodies.

Recent Amendment to the TOR

The recent amendment, declared on 29^th July 2019 by a Presidential Order, of bringing about a new mechanism of funding for defence and internal security has attracted further criticisms. It is being anticipated by a section of the intelligentsia that the Union Government might be carving out the increased demand for these from the states’ share in the divisible pool of central taxes.

The inevitable squeeze, in available resources, to be faced by the states would have far reaching implications so far as prioritising spending in vulnerable social sectors is concerned.

However, looking at it from a different analytical framework, the existing literature also points out that in freezing the Centre’s share in the divisible pool, the expenditure needs on defence and internal security are already accounted for. This would imply, that any move on the part of the Finance Commission to etch out a separate fund for the two heads from the shareable pool, would necessitate a corresponding downward adjustment to the part that the Centre can keep for its own requirements before devolving to the states. Thus, such an adjustment might not necessarily erode the states’ share in the tax kitty. What is important to point out here, however, is that, such a mechanism would preclude the states from having any say in financing for internal security which is a joint responsibility of the Union and the states, in addition to matters of defence which in any case is a central subject.

It has also been expressed that such a consideration lies outside the purview of the Finance Commission itself. The amendment requires the former to move beyond its constitutional responsibility of deciding the magnitude of devolution of resources and engage directly in the mechanism of how the Union Government will be managing the financing for particular components on the Union List.

A specific suggestion, in this regard, has been to revamp the already existent constitutional body of Inter-State Council as the effective decision-making entity in so far as designing programmes and framing the principles of allocation among states are concerned.

Thus, this amendment, in conjunction with several other clauses of the TOR, has to be looked at from not just a lens of possible shrinking in the fiscal space for states, but also from the perspective of a loss of fiscal autonomy for them. The 15^th FC, while making its final recommendations, is hoped to rethink some of these issues and take into consideration the states’ own needs and priorities in harmony with the spirit of cooperative federalism.

 

The views expressed in this piece are those of the author, and don’t necessarily reflect the position of CBGA. You can reach Simonti Chakraborty  at simonti@cbgaindia.org.