The 15th Finance Commission Has Bigger Problems Than The North Vs South Debate

Posted by Ambar Sharma in Business and Economy
April 17, 2018

The matter is quite simple. Every 5 years or earlier, according to Article 280 of the Constitution, the President constitutes a body called the Finance Commission (FC), which writes a report on how India’s Union Government and the state governments will share the divisible pool of funds (taxes). It also goes a little deeper and charts out the division between the states as well. For example, in the 14th Finance Commission report, 42% of all taxes were given to the states. How much Uttar Pradesh or Kerala will get of this 42% is also included in the report.

There is a set pattern of doing this, and the recently constituted finance commission’s decision to use the 2011 census as the basis for population data is what has ignited the controversy that the southern states are unfairly losing out to the north. The 15th Finance Commission has bigger problems.

The Terms of Reference (ToR) of this finance commission is at the root of these problems. There is a departure from other finance commissions, who have, since 1971, maintained that the 1971 census shall be the base year for the population.

Background: This was because, in 1976, Indira Gandhi’s government enacted the ‘mini Constitution’ or the 42nd Amendment, which mandated that parliamentary seats be tied to the 1971 census as well as any distribution based on population. 1971 onward, states were heavily encouraged to use family planning and control their population. They were simultaneously assured that their representation or money would not be, ironically, reduced due to their successful efforts. This was to be done till the 2001 census, after which, the status quo was extended for an additional 25 years in 2003.

Weightage in the 13th and 14th FC

In the 14th FC, the 2011 census was given 10% of the total weightage of 27.5 %. This itself led to protests of ‘missed’ revenue for southern states. The new commission is to give entire weightage to the 2011 census, which is likely to be 27.5 %.

False Dichotomy

First of all, to take a step back, India is a country. A nation described as an indestructible union. The nation includes both states and the Centre, with equal standing in a federal structure. However, in terms of taxes, the Union  has always had more power. This is why all the taxes levied and collected by the Union (subject to exclusion such as cess, surcharge, some duties, etc.) are shared with the states. This argument that southern states are ‘losing’ out on revenue goes against the spirit of the Union. Why shouldn’t states with the weakest performance indicators on population growth be compensated? Population density has always been a vital parameter for development and if India doesn’t develop its densely populated areas, the southern states stand to lose too.

It is said that southern states ‘subsidise’ the north. By that logic, doesn’t Chennai subsidise poorer villages and cities in Tamil Nadu? Doesn’t Gurugram subsidise the less well-off areas of Haryana? If the argument is based on dividing the country into states, you could always go deeper and divide it into ‘rich vs. poor districts’, ‘rich vs poor villages’, etc. One of the many ideas of our diverse nation is to reduce geographical economic inequality through an “endeavour to eliminate inequalities in status, facilities and opportunities, not only amongst individuals but also amongst groups of people residing in different areas” – Article 38 (2).

Much like a teacher who gives more attention to the weakest kid in class, taxes going to the weaker states is not a horrible idea as it serves to benefit the country, of which the southern states are a vital part.

The second argument southern states make is about their success in controlling population growth and having a better TFR (Total Fertility Rate) of below 2. That is absolutely right. This is why in the terms of reference of the FC, paragraph 7 of the order, says –

The Commission may consider proposing measurable performance-based incentives for States, at the appropriate level of government, in following areas:

7 ii) – Efforts and Progress made in moving towards replacement rate of population growth

The FC has not only not ignored success in population control, but rather has a mandate to consider an incentive to those who moved towards replacement rate of 2.1, despite which the protests continue.

Thirdly, the southern states suggest that when the 14th FC took just 10% of the 2011 census, they lost huge amounts of revenue. Tamil Nadu is said to have lost Rs. 6,000 crores according to a gentleman due to the change in allocation since the 14th FC. The problem is, apart from the 4 southern states, 10 other states were able to ensure a decline in population share such as Orissa, Punjab, West Bengal, Himachal Pradesh and Goa. Did these states also lose revenue? No. Goa was in fact, according to the numbers of the same gentleman, the biggest gainer after the change in weightage in the 14th FC. Punjab was also a gainer and so was West Bengal. Even the southern states themselves did not get too affected. Kerala was also a beneficiary from the 13th FC to the 14th FC, as its share in taxes jumped from 2.341% to 2.500% (a gain of 6.8%) and so did Karnataka from 4.328% to 4.713% (gain of 8.9%).

Interestingly enough, Bihar was a loser (down by 11.47%) and so was Uttar Pradesh (down by 8.73%) when the 2011 census was taken.

Basically, just because you take the 2011 census does not mean the states which have been successful in family planning will lose revenue. There is little correlation. More than population, it is migration that is a bigger issue. Since people from UP or Bihar move out and migrate to other states in search of better opportunities, this reduces the population of these states and is sometimes more than the number of births, which means less money for these states. These are states that need more money in the first place. States whose youth workforce migrate in droves  and who need more money to provide better facilities and did not get that, according to the last FC.

Fourthly, the share in the union taxes is just one way for the state to generate revenue. The bulk of some states’ revenue is from the taxes the states have exclusive rights to, which are, described in detail in the State List. For example, land revenue, tax on buildings, tax on electricity, tax on alcohol, etc.

According to state budget documents, there is a big divide between the south and north states, in terms of the source of revenue. For 2017-18, consider the following points –

  • Kerala & Tamil Nadu raised 70% of its revenue on its own
  • Karnataka raised 67% of its revenue on its own
  • Telangana raised 61% & Andhra Pradesh raised 47% of its revenue on its own

In contrast –

  • Bihar had to depend on its share in Central taxes as well as Central grants for 50% of its total revenue
  • UP had Central taxes & Central grants amounting to 44% of its revenue
  • For Madhya Pradesh, this was 45%

The ability of southern states to raise revenue is extremely important as they are less dependent on the Centre for its taxes. That, by no means implies that they deserve less, but serves to display the reliance of the northern states on central taxes and grants. This (fiscal capacity) also accounted for 50% of the weightage in the last FC. Yet, these states, as shown above, incrementally lost share in the 14th FC.

Finally, to take a step back again, there have been many measures which have reduced economic inequality in India. One shining example was the Freight Equalisation Policy. Here, Bihar was mainly affected and states like Kerala, Tamil Nadu, which were along the coast line, benefited. Bihar’s business was reduced greatly, but the country benefited overall. This will also happen – a net positive for the country, if more funds are given to those who genuinely need it.

Real Issues

Not to take anything from this debate, which has its own place, but there are pressing issues that have been ignored by the media. There are 3 important issues that don’t affect just a region, but the autonomy of all states.  These are:

  1. Re-thinking revenue deficit grants
  2. Expenditure on populist measures
  3. Union schemes

1. In paragraph 5 of the ToR, there is a sneaky line at the end which says

“The Commission may also examine whether revenue deficit grants be provided at all.”

Revenue deficit grants are extremely important. Since a lot of states do not have the capacity to fund their revenue deficits, they rely on these grants to help meet that gap. They are a large part of the central grants and in the last FC, 11 states were deemed to be in need of them, which included Kerala and Andhra Pradesh, along with J&K, West Bengal, etc.

Rs. 1.94 lakh crore was given to 11 states for 5 years in the last FC, which overturned the projected revenue deficits of a lot of them. They are vital to keep the states’ heads above the water for expenses that are regular, such as interest payments on loans or salaries for government officials.

Apart from being important, they are also constitutionally enshrined in Article 275. Article 280 (3) (b) also talks about grants-in-aid of the revenues of the states. Not giving them the grant would be violative of both articles.

How will the states pay for their employees’ salaries? Or their subsidies to people if they don’t get this grant? Has this finance commission forgotten the vital rule of giving states more autonomy?

2. Another sneaky line comes in the form of paragraph 7 –

7 viii) Control or lack of it in incurring expenditure on populist measures  

Who decides what is populist? Are they just excessive subsidies or schemes that put a burden on the exchequer? If so, what is the ceiling/limit? How much time is needed to decide that the scheme does not pay for itself? Who decides the number of people the scheme needs to benefit before it can be declared populist? Do all schemes need to be financially prudent? Aren’t there a number of schemes that were considered populist before they were unanimously acclaimed and accepted?

3. The final sneaky line is –

7 (iii) Achievements in implementation of flagship schemes of Government of India, disaster resilient infrastructure, sustainable development goals, and quality of expenditure;

All states will be judged on the basis of how well they implemented flagship schemes of the Union. The question all state finance ministers need to ask is – why?

Why do the states need to implement anything at all? What if they do not agree with the ideological solution of the Centre, or if the amount the Centre allocated to a certain state was a lot less than necessary to implement it well? This goes against the federal nature of our governments by ensuring that the Centre’s schemes take precedence, over the state’s own. Also, there are plenty of schemes of the central government that the states have neglected or set aside because they have a similar scheme, which they are successfully running.

The anger the southern states feel right now is about the ToR. I see this anger with a deeper root. That is the increasing divide – political and economic – between the northern and southern states. It is a fact that unity in diversity is a critical point of our democratic setup, but the chants of sub-nationalism and even Dravida Nadu reveal that the fractures are deeper and not confined to this issue. This sensitive matter must be resolved. But it shall, like all sensitive issues, take time. It is the duty of the Centre to bind the states together cohesively as one unit, one nation.

Featured image: pranshu rathi/Flickr