Editorial 2 : The States Want More
Context: As states want more, the 16th Finance Commission will have to walk a tightrope on equity and efficiency
Introduction: In their suggestions to the 16th Finance Commission (FC), several states have argued in favour of increasing their share in the divisible tax pool. Some states have even called for raising the states’ share up to 50% from the current 41%.
Rationale for States' Demand
- Reduction in Divisible Tax Pool
- The 14th Finance Commission (FC) raised states’ share to 42%, but the 15th FC reduced it to 41% after Jammu & Kashmir’s UT status.
- The divisible tax pool (taxes shared with states) shrank from 88.6% in 2011-12 to 78.9% in 2021-22 of the Centre’s gross tax revenue due to increased reliance on cesses and surcharges which were not shared with states.
- States now receive only 32% of gross tax revenues on average over the past six years.
- States’ Grievances
- Demand for a 50% share in the divisible pool to offset reduced transfers.
- States call for limiting cesses & surcharges to ensure a larger shareable pool.
Key Considerations for the 16th Finance Commission
- Fiscal challenges for the central government.
- Quality of state expenditure.
- Equitable delivery of public services.
- Devolution to local governments.
Fiscal Challenges for the Central Government
- Current Burden
- States already account for about 60% of general government expenditure.
- Increasing untied transfers could strain the Centre’s fiscal capacity, especially with rising demands (e.g. defence, infrastructure).
- Centrally-Sponsored Schemes (CSS)
- CSS are used by the Centre to fund state and concurrent list items (e.g. welfare schemes), often driven by political or developmental imperatives.
- CSS have led to the Centre borrowing to fund transfers, as grants exceed its revenue deficit.
- Reforms Needed
- Rationalize CSS to rebalance tied (scheme-specific) and untied (flexible) transfers.
- Re-examine the Centre’s expenditure priorities to create fiscal space for Union-list responsibilities.
Quality of State Expenditure
- Worsening Revenue Balances
- States like Karnataka and Punjab face rising revenue deficits. They are borrowing for subsidies, salaries, and interest payments.
- Punjab’s fiscal deficit is driven by a high revenue deficit, limiting capital expenditure.
- Risk of Misallocation
- Untied funds could be diverted to non-merit subsidies (e.g. power, water) or cash-transfer schemes.
- 14 states have introduced income transfer schemes (totalling 0.6% of GDP), raising concerns about fiscal prudence.
Equitable Delivery of Public Services
- Inter-State Inequality
- Wide disparities in spending (e.g. Bihar vs. high-income states).
- Untied transfers may not ensure convergence in service delivery without safeguards.
- Intra-State Inequality: Lack of accountability in fund usage could exacerbate regional disparities within states.
Devolution to Local Governments
- Weak Third-Tier Governance
- Local governments in India account for less than 5% of total spending, far below peers like China and South Africa.
- States restrict devolution of funds and functions to municipalities and panchayats.
- Opportunity for Reform: Greater untied transfers could incentivize states to empower local bodies, but political resistance remains a barrier.
Potential Implications and Way Forward
- Balancing Fiscal Autonomy and Responsibility
- For the Centre
- Cap cesses and surcharges to expand the divisible pool.
- Rationalize CSS to reduce overlapping expenditures.
- For States
- Link higher transfers to fiscal discipline (e.g. revenue deficit targets).
- Mandate transparency in spending outcomes.
- Addressing Inequality and Service Delivery
- Introduce performance-based incentives for states to improve social sector outcomes.
- Create a convergence fund to bridge inter-state gaps in critical areas like health and education.
- Enhancing Local Governance Structures
- Tie a portion of untied funds to mandatory devolution to urban and rural local bodies.
- Strengthen accountability mechanisms for third-tier institutions.
Conclusion: The 16th Finance Commission faces a complex trade-off between states’ legitimate demand for greater fiscal autonomy and the risks of fiscal indiscipline, inequity, and misallocation. A balanced approach, limiting cesses, rationalizing CSS, and linking transfers to accountability, could address these challenges while fostering cooperative federalism.