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The floods in Kerala and the quantum of aid it needs versus what is on offer from the Centre has brought back the debate on Centre-State issues. It is also pertinent since the Fifteenth Finance Commission (15FC) is in the middle of deciding the devolution framework and quantum. In Kerala’s case, it must receive the full amount of its assessed need. Anything short of this would not do justice to the spirit of cooperative federalism and deep inter-dependencies that make the States and the Centre work as one nation. The ugly North-South rhetoric being stirred up in this context as also on the terms of the 15FC is absolutely misguided to say the least.
Some States believe they “contribute” more to the exchequer than what they “receive” in return. This language of give and take is problematic to begin with, because it fails to capture the synergy and externality benefits that States derive from remaining in the Union. For instance, balanced and sustainable development of the nation is in the interest of all States, which can lead to benefits like less pressure of migrant populations. If some States develop massive forest and green cover, like Kerala, the benefits go far beyond the boundaries of that State.
India is a Union of States, and indeed the States are the creation of the Union. It is not a federation of States who have come together voluntarily and signed a treaty. Living together as a Union is an imperative, not a choice. Compare this to a cooperative housing society. Members live together and pay fixed society charges that cover a gamut of costs -- security, lights in the common areas, water charges, the lift, the garden and sundry maintenance. If you live on the first floor and never use the lift, do you ask for a partial refund on lift charges? Do you see yourself as subsidising those on the upper floor who use the elevators? The society is the sum total of its members, who have to live together in harmony. They collectively enjoy externality benefits which are intangible, non-monetary, and outweigh the narrow calculation of cross subsidy.
This same issue of cross subsidy comes up in the discussion around 15FC. Some States believe they “contribute” more to the exchequer than what they “receive” in return. This language of give and take is problematic to begin with, because it fails to capture the synergy and externality benefits that States derive from remaining in the Union. For instance, balanced and sustainable development of the nation is in the interest of all States, which can lead to benefits like less pressure of migrant populations. If some States develop massive forest and green cover, like Kerala, the benefits go far beyond the boundaries of that State. This means more resources need to flow toward more backward or greener states. Similarly, natural calamities respect no arbitrary State boundaries and spill over. In such a case too, large central assistance needs to flow to the affected state. The considerations like balanced development, disaster mitigation and relief, reducing pressure of migration, increasing forest cover, all call for large redistributive flows.
The foremost consideration to split the pie among the States is funding the “gap”. This is the gap between the State’s own revenue raising capacity and what it needs to spend to discharge its most basic obligations to its resident citizens. The divergence in the per capita income levels of different States is a historic reality, and we must not allow this divergence, or regional inequality to go out of control.
In India, taxes are all collected centrally (for that is efficient) and then distributed back to the States. The distribution is done on the basis of a constitutional mechanism called the Finance Commission. The devolution is a two-step process. In the first step, a certain portion is held back with the Centre (called vertical devolution), to take care of the expenses of the Centre’s obligations (such as national defence or space and nuclear programme or disaster relief). The second step is to distribute the remainder among all States in a rational, logical manner. This is the horizontal devolution.
The foremost consideration to split the pie among the States is funding the “gap”. This is the gap between the State’s own revenue raising capacity and what it needs to spend to discharge its most basic obligations to its resident citizens. These are services like law and order, roads and transport, primary health and education. Different States have varying extent of the gap (expressed as a percentage of their State’s per capita income or GDP). The poorer the State, the lower will be its own revenue raising capacity, and higher its “gap filling” need. The divergence in the per capita income levels of different States is a historic reality, and we must not allow this divergence, or regional inequality to go out of control.
The other big and bothersome reality is that all States of India have a revenue deficit on a pre-devolution basis. They start off with a negative balance. This is because in the totality of Centre plus States, two-third expenditure happens at the State level, whereas only one third is the revenue raised by them on their own (pre-devolution). This can be corrected if for instance, we change the split of the central GST collection from 50:50 to say, 60:40 in favour of the States. At least this way, the “gap filling” burden of the Finance Commission will be lower, and the feeling of “heartburn” of richer States subsidising the poorer States (in per capita sense) would be substantially reduced.
The situation is being made worse because the Centre has slowly encroached on States’ domain as defined in the Seventh Schedule of the Constitution. The Seventh Schedule has three lists respectively called the Union, States and Concurrent lists. We find that increasingly the Centre has taken on obligations which fundamentally ought to be in the States’ domain.
The Food Security Act of 2013 is a case in point. That added anywhere between 1 to 2 per cent of GDP as an additional annual burden on the Centre’s budget, which means the Centre must keep more of the taxes to meet these obligations and the States will get that much less in the devolution. The Act was opposed tooth and nail, but eventually was passed by Parliament.
We may have created a situation where the Finance Commission has to do fairly large redistributive transfers purely based on primary obligations. This may ruffle feathers and give more fodder to talk like the North-South divide. But remember, as in the case of the members of the co-op housing society, we are all in this together. The spirit of cooperative federalism and unity in diversity must prevail.
The recent initiative of Universal Health Insurance (Ayushyaman Bharat) is another example which will increase the Centre’s financial burden, creating need for more resources to the central pool and pulling them away from the States. The hiking of minimum support price (MSP) to 50 per cent above the cost of production is a third example. Food, health and agriculture are in States’ list, but have been given national color and priority. The Centre is now involved in activity which was primarily the States’ mandate. Perhaps this is being justified because there are nation level ramifications.
Thus, we may have created a situation where the Finance Commission has to do fairly large redistributive transfers purely based on primary obligations. This may ruffle feathers and give more fodder to talk like the North-South divide. But remember, as in the case of the members of the co-op housing society, we are all in this together. The spirit of cooperative federalism and unity in diversity must prevail.
(The writer is an economist and Senior Fellow, Takshashila Institution)