15th Finance Commission (FC) – Issues in News

In this article, you can read about the 15th Finance Commission (FC), its importance and background for the UPSC exam.

15th Finance Commission Importance

The 15th FC has been set up in a time when huge reforms have been taken under the fiscal federalism:

  • Replacement of Planning Commission with NITI Aayog
  • Implementation of GST reforms
  • Abolition of the planned and non-planned expenditure

Finance Commission Introduction

  • Article 270- sharing of central taxes
  • Article 275- grant in aid of revenues (grant-in-aid/statutory grants/non-plan grants are to be given to the States in need of assistance and the amount of grant-in-aid and the principles for judging the eligibility of states for these grants-in-aid are to be determined by the Finance Commission)
  • Article 280- provides the main responsibilities of the finance commission
  • The central government collects majority of the taxes in the form of Income tax, Corporate tax, Customs, Central GST etc whereas it is the state which needs to provide a huge amount of services to the public hence it is natural for the states to fall into revenue imbalance/gap
  • Prior to 2000, only Income tax and union excise on certain duties were shared but the constitutional amendment in 2000 allowed all the central taxes to be shared with the states
  • The government has amended the constitution twice – 80th CAA and 88th CAA in 2000 and 2003 respectively in order to change the scheme of distribution of taxes between the centre and the states
  • The tax sharing is done so as to correct the vertical and horizontal imbalances which arise due to constitutional assignment of tax powers and responsibilities of the expenditure
  • The tax sharing recommendations given by the FC does not form part of the consolidated fund of India

Finance Commission Background

  • Since the 90s it has also started to recommend regarding the augmentation of revenues at the local government level
  • The usage of population of 1971 for deciding on the horizontal devolution was made mandatory from the 7th FC, having said so it should be remembered that the 6th FC also used the 1971 population but wasn’t mandated to use it
  • 2011 data along with the 1971 population data was used by the 14th FC (if it had used only the 1971 population then the data would have a margin years of 45 years to 50 years during the implementation from 2015 to 2020)

Why these transfers are important?

  • The central taxes that are devolved are basically the untied funds and these can be used as per the discretion of the states
  • Apart from this, such revenues transferred have comprised of over 80% of the central transfers to the states
  • Apart from these funds the centre allocates the grants to states and local bodies
  • If the 15th FC considers population of 2011, then along with southern states, Punjab, WB, Assam, Maharashtra will also be on losing side

15th Finance Commission

  • Constituted by the President in November 2017
  • It is headed by N K Singh
  • deliberation period from end of 2017 to end of October 2019
  • The recommendations would be applicable for the period from 2020-2025
  • Terms of References
  • The distribution of tax proceeds between the centre and states
  • Principles governing grant in aid to the states
  • Measures to be taken to augment the consolidated fund of states
  • Review the impact of the 14th Finance Commission recommendations on the fiscal position of the centre
  • Review the debt level of the centre and states, and recommend a roadmap
  • Study the impact of GST on the economy
  • Recommend performance-based incentives for states based on their efforts to control population, promote ease of doing business, and control expenditure on populist measures, among others
  • Should there be a provision of revenue deficit grants?

15th FC Concerns

2011 Population

  • Before the 42nd CAA of 1976, deciding the distribution of the Lok Sabha seats was determined by the population in the last preceding census. The 1971 census showed a huge jump and then the family planning was introduced at the policy level (but remember that the family planning measures have been implemented in India since 1950s but came to forefront only during 1970s)
  • According to the Constitution, there are four areas in which population is used as a factor
    • Manner of Election of President – Article 55
    • Composition of the House of the People – Article 81
    • Composition of the Legislative Assemblies – Article 170
    • Reservation of seats for Scheduled Castes and Scheduled Tribes in the Legislative Assemblies of the States – Article 330
  • Supporting Points for usage of 2011 population
    • The population of 1971 would have been a 45-50 years old data which may not represent the present situation
    • The argument of the southern states that they have controlled the population growth is true but there is no proof that the northern states have supported the proliferation of the population through the policy measures
    • FC has to ensure that the poorer states have adequate resources to promote socio-economic development, critical infrastructure, balanced regional development etc
    • The 1971 population does not take into consideration the issue of migration. Which is observed at a very large scale in today’s scenario
      • As per the census of 2011, stock of migrants is around 3.3 million per annum
      • As per economic survey 2016
        • The inter-state migration stood at around 5-6 million per annum (between 2001 and 2011)
        • The rate of change of growth in annual migration was about 2.4% from 1991 to 2001 and has almost doubled to 4.5% for the period 2001 to 2011
      • The FC allocation helps in providing the economic and social services to the population. But taking older population may not lead to right amount of services to be provided by the states
      • The concept of demographic dividend will only lead to results if the population is given access to right education, nutrition, skilling etc and the larger states in terms of population will require this kind of assistance
    • Concerns/Worries regarding the usage of 2011 population
      • The share of southern states out of India’s population has decreased by 4 percentage points (between 1971 to 2011) whereas the share of northern state in the same time has increased
      • The per capita income of AP, Telangana, TN and Karnataka is almost twice that of states such as Bihar, UP, MP, Rajasthan etc
      • There is no denying that the rich states will have to help the poorer states but the developmental gap has not narrowed even after providing the assistance for decades
      • The grand bargain done under GST has led to some rule-based distribution of revenues between the centre and states and not dependent on the population of the states
      • Does the FC incentivize/reward backwardness?
    • Hierarchical to command and control relations – after the abolition of the Planning Commission the 15th FC becomes very important but the ToRs have been skewed in favour of the central government like the one which deals with review of enhanced allocation of funds because of 14th FC recommendations and its impact on the fiscal situation of the central government keeping in mind the imperatives of the national development programme

The reduction of funds going to states may not necessarily mean a bad thing as the central government is more important in terms of industrial growth, inter-generational concerns, environmental concerns etc as in such cases the centre is suited better compared to the states to take care of the issues

Abolition of revenue deficit grants

If the revenue deficit grants are to be phased out then the government should bring some other mechanism in its place. One way would be to provide the grants from case by case basis.

North Vs South

  • The southern states are not alone in reduction of population share. Apart from the four southern states, there are many more states whose population share has reduced between 1971 to 2011 (these are Assam, Goa, Himachal Pradesh, Odisha, Punjab and West Bengal
  • There are some western states (such as Gujarat, Maharashtra) and northern states (such as Punjab, Haryana etc) which have received lesser than what they have paid to the central government
  • Maharashtra, Gujarat, Haryana and TN receive lesser than Rs.30 (taxes devolved and other transfers) for every Rs.100 they contribute to the central exchequer. In contrast Bihar, UP received more than Rs.200 and around Rs.150 respectively for every Rs.100 they contributed to the central exchequer
  • Looking at the above point the devolution may seem to be very progressive but when per capita income is compared with per capita transfers received, the story changes. Under this, the southern states are getting better devolution compared to northern states such as UP, Bihar
  • Compared to large developing democracies India’s devolution looks much more regressive. In case of India, the bottom 25% of the states received 22% of the transfers it was 30% and 36% in the case of South Africa and Brazil respectively
  • The states such as UP appear to be dependent on the central transfers primarily because of their population. In fact, certain parts of UP are richer than some of the regions in other states

BIMARU Vs the Southern states – Then and Now (1971 and 2011)

Population

  • In 1971, the BIMARU states had 57% more population than the southern states and today it twice that of southern states
  • The total population of four southern states is lower than the combined population of UP and Rajasthan
  • The northern states’ share of population has increased from 38.7% (1971) to 42.4% (2011) whereas that of southern states has fallen down from 24.7% to 20.7%

Total Fertility Rates (TFR)

  • TFR for India was 5.5 in 1971 and has been brought down to 2.3 by 2013
  • The southern states’ TFR ranged between 3.9 for TN to 4.6 in AP in 1971, which was way below the national average. By 2013 it has been brought down to the range of 1.7 to 1.9
  • The northern states’ TFR in 1971 was over 6 and by 2013 has been brought down to the range of 1.9 to 3.4

Size of the Economy

  • At 1980-81 prices the size of the BIMARU states was 32% larger than the combined size of the southern states
  • By 2016-17, the economic size of the southern states is 15% more than the northern states

PCI

  • The per capita income of southern states is much higher than that of northern states (the lowest PCI in a southern state is of Rs.95566 which is more than the PCI of Rajasthan Rs.72072-highest amongst the northern states)

Contributions to direct taxes

  • Southern states contributed 23.5% whereas northern states’ contribution was just 9.7% (Karnataka contributed 10.1%)

Conclusion

  • Giving a lower weightage to 2011 population
  • Including the population of 1971 also
  • Providing incentives to the states which have better performance in the population control reforms
  • It is premature to jump to conclusion regarding the shares of the southern states as the finance commission is yet to come out with the weightages to various parameters to determine the horizontal formula
  • Equalization approach as in Australia and Canada wherein the financial resources are allocated so as to ensure that services are provided in each of the states at comparable levels provided the states make comparable efforts in raising the revenues. In case of India the FCs basically follow gap-filling approach dependent on the historical trends of expenditure and revenues.

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