42% Share of States in Central Pool of Taxes Will Cement the Central State Relations
Finance Commission is a constitutional body deriving its origin from Article 280 of the constitution according to which, every five years, President of India will constitute a Finance Commission to define the financial relations between the central and the state governments. The Fourteenth Finance Commission (FFC) was constituted in year 2012 to recommend about the devolution of taxes between central and the state governments among others for five year period from 2015-20.
Some of the major recommendations of FFC are as under –
- Tax devolution should be the primary route for transfer of resources to the States with share in central pool of taxes at 42%
- Maintenance of centre’s fiscal deficit at 3% of GDP from 2016-17 onwards with states’ fiscal deficit anchored to similar annual limits likewise
- Broad parameters used for tax distribution formula are - population (1971), changes in population since then, income distance, forest cover etc.
- Modification or replacement of the current FRBM (Fiscal Responsibility and Budget Management) Act with a debt ceiling and fiscal responsibility legislation.
- A steady lowering of subsidy bill from 2% of GDP in 2014-15 to 1.6% in 2015-16 and to 1% by 2019-20 with corresponding increases in capital expenditure from 1.8% to 2.9% of GDP
The FFC has increased the share of states in the central pool of taxes by 10 percentage points from 32% to 42%. This would mean that total devolution to states in 2015-16 will be INR 5.26 lakh crore against INR 3.48 lakh crore in 2014-15, representing a rise of INR 1.78 lakh crore. Finance Commission has also earmarked INR 2.87 lakh crore for panchayats and municipalities during 2015-20. With the additional funds in their hands, states would now have greater flexibility to mould the various central government sponsored schemes according to their needs.
The FFC justified its recommendation in increasing the states share citing that cess and surcharges do not form the part of the divisible pool of central taxes. The share of cess and surcharges in gross tax revenue of the Union government increased from 7.53% in 2000-01 to 13.14% in 2013-14.
The PM in his speech in LokSabha has hailed the latest recommendations FFC as revolutionary which marked a shift from “rigid centralised planning forcing a 'One size fits all' approach on states. States have always been voicing their opposition to this philosophy for years”.
Loss to The States
According to some estimates, the erstwhile tax-share of the states of 32%, when adjusted for central assistance, grants, etc., works out closer to 39%. When FFC has recommended a primacy of divisible pool of taxes over grants as source of state finances, the amount of grants released to the states by centre are likely to get reduced. Therefore, it is actually the restructuring of resource sharing where amount of grants is reduced and share in taxes in increased. Thus overall increase in amount transferred to the states including grants and divisible pool of taxes would be less than what it seems at first.
It also means that from now onwards, central government will reduce its funding to the various centrally sponsored schemes operational in the states which would now be majorly funded by states themselves. So if the PM said that states have discretion to run the schemes as per their needs and discretion, he also meant that states would now have to share the financial burden of these schemes as well.
For that matter, at an all party meeting in Bihar, it was decided to write a letter to the PM about the "estimated Rs 50,000 crore loss" to the state due to the 14th Finance Commission recommendations.
Future Of Central State Relations
However, balancing both the losses and the benefits to the states, the result would give more positives for the states. Though it is true that share of grants to the states is reduced, it also confers more autonomy to the states. A state which is fully dependent on the centre for its finances can never have cosy relations with it.
Traditionally, states were never provided financial autonomy to generate funds from the markets which resulted in their poor finances and dependence on centre. In fact, Indian states were dubiously called as ‘glorified municipalities’. For that matter, increased resources for the states is a right step in improving the financial health of the states. As far as central state relations are considered, their course in India depends more on politics than economy.
A Congress ruled state could hardly have cosy relations with BJP government in the centre and BJP ruled states would always have good relations with similar government in centre irrespective of issues. In near future, similar trend is likely to continue between the centre and state relations.