Facade of co-operative federalism is falling apart

Allocation of financial resources is best undertaken by the tier of government which is nearest to the beneficiaries and mobilisation of resources is best undertaken by the tier of government that is farthest from the tax payers.  It is for this reason that in all federations, taxation powers are generally concentrated at the Centre while the burden of expenditure is mostly on the States. To address this fiscal imbalance, there would have to be some constitutional mechanism to transfer resources from the Centre to the States.  In India, the Union Finance Commissions appointed under Article 280 of the Constitution after every five years is the institution for recommending the vertical division of resources between the Centre and State as well as the horizontal distribution of the devolved resources between the States. In other words, sharing is not gratis from the Centre, but a constitutional right. However, the formation of the Finance Commissions (FCs) and deciding their terms of reference (TOR) has been the exclusive preserve of the Centre and this is against the grain of federalism.

When the State finances are likely to be stressed in the immediate future due to a) Pay Commission Awards, b) problems in implementation of GST c) need for spending in social and economic sectors and d) interest liabilities on UDAY bonds, the TOR if implemented would severely strain the State finances.

Scuttling the Fiscal space of the States 

From the 1990s, the FCs have also become a vehicle for incentivising and coercing the States to implement fiscal reforms like deficit targeting. This is done citing the Constitutional provision enabling recommendations in the interest of sound finance, i.e. Article 280(2) (c). The FCs, since the 11th, have been consistently doing this by linking grant disbursement and debt relief packages to implementing Fiscal Responsibility and   Budget Management Acts (FRBMA), adhering to zero Revenue Deficits (RD) and three percentage Fiscal Deficit-GSDP (Gross State Domestic Product) ratio.  A look at the TOR of 15th FC leaves no doubt in one’s mind that this role is being carried further.

The FRBMA Review Committee, 2017, had recommended that instead of deficit targeting, Debt-GSDP ratio should be anchored to 60 per cent level (40 per cent for the Centre and 20 per cent for the States), and accordingly Fiscal  Deficit-GSDP ratio should be glided  down to 2.5 per cent for the Centre and 1.7 percent for the States by 2022-23. This is a sharp reduction from the present three percent level. Unless the revenue position of the Centre as well as the States improves markedly (which is unlikely at present), this would necessitate a substantial expenditure compression. The tenor of the TOR gives a feeling that the 15th FC may become an instrument to enforce curtailment of the fiscal space of the States. 

Another area of concern is doing away with the1971 population as a criterion for tax devolution (TOR 8). States which have achieved demographic and health indicators and controlled the increase in population would substantially lose and their loss will be in proportion to the weight the 2011 population criterion gets in the Tax Devolution formula.

In what could be debilitating for the States’ finances, the TOR also suggests whether there should be Revenue Deficit grants at all. Till the 14th FC, post tax devolution Article 275 grants-in-aid were called Non-Plan Revenue Deficit (NPRD) grants, and were an important part of central devolution and a means of augmenting the Consolidated Fund of the State. The 14th FC awarded Revenue Deficit (RD) grants, taking a holistic view of plan and non-plan revenue expenditure. When the State finances are likely to be stressed in the immediate future due to a) Pay Commission Awards, b) problems in implementation of GST c) need for spending in social and economic sectors and d) interest liabilities on UDAY bonds, the TOR if implemented would severely strain the State finances.

TOR 7 (viiii) is about “Control of lack of it on Populist measures”. This is vague and open to wide interpretations.  Through this, the FC would get authority to restrain democratically elected governments from implementing promises made to the people in the election manifestoes. Any measure from welfare pensions to food subsidy can be selected for attack. This strikes at the root of democratic polity. 

Exacerbating the divide between the States

Another area of concern is doing away with the1971 population as a criterion for tax devolution (TOR 8). States which have achieved demographic and health indicators and controlled the increase in population would substantially lose and their loss will be in proportion to the weight the 2011 population criterion gets in the Tax Devolution formula. A look at the comparative position of the States when the 1971 and 2011 population is used shows that all Southern States, Goa, Orissa, Assam, Himachal Pradesh, Punjab and West Bengal would be losing when the criterion is the population in 2011. 

For Karnataka, the share of population in the national total has gone down 0.25 per cent. It is pertinent to note that the losing States like Kerala have reached replacement rates of Population and are now not able to reap the demographic dividend of the new labour force. They have also incurred a huge cost to achieve this progress and now are bearing the burden of revenue deficits. Their loss needs to be considered in the tax devolution formula, lest the 15th FC award becomes a disincentive for achievements in human development, which has come through conscious public action.

All talk of Co operative Federalism seems to have evaporated into thin air, as can be seen from the TOR. States will have to effectively take a position on these issues in their memorandums to the 15th Finance Commission, if they are to retain their rightful position in the federal polity.

Anti-federal tenor seen in TOR

The FCs becoming a monitoring agency is not befitting its Constitutional role. As the Finance Commission is not an ongoing body, any monitoring mechanism suggested by it would become a Central officials’ supervision over the State governments.

The part of TOR 6 (iv) challenges the basic framework of federalism. It states: “The impact of the fiscal situation of the Union Government of substantially enhanced tax devolution to the States following recommendation of the 14th FC, coupled with the coming imperative of national development programme, including New India-2022.”  In a framework of Cooperative Federalism, there has to be a consensual approach and States and Local Self Governments, being closer tiers to the people benefiting from the programmes, should have the prime role. 

A substantially enhanced devolution would naturally ensure implementation of these programmes in a better way and there should not be any room for the apprehension expressed in the TOR 6 (iv). In fact, a larger untied allocation for measurable outcomes, should be better than the Centre spending from its own resources as tied grants. 

All talk of Co operative Federalism seems to have evaporated into thin air, as can be seen from the TOR. States will have to effectively take a position on these issues in their memorandums to the 15th Finance Commission, if they are to retain their rightful position in the federal polity.

(Dr. T M Thomas Isaac is the Finance Minister of Kerala)