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Eleventh Finance Commission -- An opportunity missed

Against the backdrop of coalition party politics, it is indeed a daunting task to devise a devolution package satisfying the overall financial needs of the States. The Eleventh Finance Commission has missed the opportunity to develop a set of criteria wh ich could satisfy the long-standing needs of the States, says P. Jegadish Gandhi.

SINCE civilisation, the socio-political system has been revolving around resource accumulation and its allocation. The devolution, distribution and determination of financial flows between the suzerain power and its subordinates have been controversial i ssues through the ages.; it was between the despot and its dependent principalities during the ancient Kingdoms and the Imperial government and its submissive provincial entities during the British rule in India.

The transfer of resources from the Centre to the States is a salient feature of the post-Independence financial system. In the last few years, there have been simmering and open conflicts between the Indian Union and the States in the devolution of fisca l and financial resources due to the political and ideological differences among the ruling parties in the federal States. This has been aggravated by the successive multi-party coalition governments at the Centre in recent times. The excessive dependenc e on the Centre's devolutionary directives and the aggressive demands of the State governments open up new thrust areas and perspectives in federal financial relations.

Under the provisions of Article 280 of the Constitution, the President is required to appoint a Finance Commission for the specific purpose of devolution of non-Plan revenue resources. The functions of the Commission are to make recommendations to the Pr esident in respect of the distribution of net proceeds of taxes to be shared between the Centre and the States and the allocation of share of such proceeds among the States; the principles which should govern the payment by the Union of grants-in-aid to the revenue of the States, and other matters concerning financial relations between the Centre and the States. The appointment of the Finance Commission is of great importance as it enables the financial relation between the Centre and the units to be al tered in accordance with changes in needs and circumstances. The elasticity in relationship introduced by this provision is an advantage.

Eleven Finance Commissions have so far been appointed by the Government since 1951. Their recommendations are generally grouped under three heads -- division and distribution of income-tax and other taxes; grants-in-aid; and loans to States. The terms of reference of the Eleventh Finance Commission (EFC), under the Chairmanship of Prof. A. M. Khusro, include the devolution of Central tax proceeds and grants-in-aid to States; recommended measures on issues concerning the States' debt positions; calamity relief; and fund requirements for the upgradation of standards and pay revision of State government employees. Besides, for the first time, the Commission has been mandated, in terms of the 73rd and 74th Constitutional amendments, to suggest measures to augment the Consolidated Fund of a State to supplement the resources of panchayats and municipalities.

The major recommendations of the EFC are: A 29.5 per cent share in the Union taxes and duties to States (28 per cent of the net proceeds plus 1.5 per cent in lieu of sales tax on sugar, tobacco and textile products); an indicative limit of 37.5 per cent for transfer of the Centre's gross revenue receipts -- tax and non-tax -- to States; a 7.5 per cent weightage to fiscal discipline for determining the inter-State share of States; and a higher provision of grants to the tune of Rs. 58,000 crores, against the TFC's transfer of Rs. 20,000 crores.

Besides, the EFC has recommended a surcharge on Central taxes to raise resources to fight national calamities with the existing Calamity Relief Funds in the States; a grant of Rs. 10,000 crores for local bodies in 2000-05 to be used for maintenance of ci vil service; a proposal to bring service sector under the taxable net; and a goal to achieve zero revenue deficit for all States by 2004-05.

It is claimed that the States would gain significantly from the higher vertical transfers of shareable taxes and grants. As per the EFC's estimate, a total of Rs. 4,34,905 crores would be transferred to the States. Of this, Andhra Pradesh would get Rs. 3 1,011 crores, Tamil Nadu Rs. 21,601 crores, Karnataka Rs. 19,691 crores, Kerala Rs. 12,316 crores, Maharashtra Rs. 19,387 crores, West Bengal Rs. 35,219 crores, Uttar Pradesh Rs. 78,509 crores, Gujarat Rs. 12,000 crores and Madhya Pradesh Rs. 34,998 cror es. The States' share in the shareable pool of taxes and duties is expected to go up from Rs. 54,060 crores this year (2000-01) to Rs. 63,025 crores next year to Rs. 73,495 crores in the third year, Rs. 85,724 crores in the fourth and Rs. 1,00,014 crores in the fifth year (2004-04).

Against the backdrop of coalition party politics, both at the Central and State levels, it is indeed a daunting task to devise an acceptable devolution package satisfying the overall financial needs of the States. The EFC has missed the opportunity to de velop a set of criteria which could satisfy the long-standing needs of the States, thereby achieving the objective of `equalisation' in federal financial relations.

No doubt, the successive Finance Commissions have tried to bring about increased resource-devolution only by tinkering with the proportion of shareable revenues and the criteria which the resources are to be transferred. That the Finance Commission mecha nism has not made much of a dent in the redistributive function is clear for two reasons:

First, from the Fifth to the Tenth Finance Commissions, the percentage of Central revenue transferred to the States declined from 27.9 to 24.5. There was an almost continuous fall from 26.09 per cent in the Seventh Commission to 22.74 per cent in the Nin th, and this marginally improved to 24.5 per cent in the Tenth Commission's award. Second, between the Ninth and Tenth Finance Commissions, the per capita transfers were higher for the high-income States, such as Maharashtra, Gujarat and Punjab, and less for the low-income Uttar Pradesh, Rajasthan and Orissa. The EFC's award has come as a major disappointment to the southern States, which find their share of the total Central transfers substantially lower than it was under the Tenth Finance Commission. Tamil Nadu's share has come down from 5.8 per cent to 4.97 per cent; that of Andhra Pradesh from 7.78 per cent to 7.13 per cent; Karnataka (4.64 to 4.53); and Kerala (3.41 to 3.05). In this process, the southern States stand to lose a total of Rs. 12,204 crores in their share of Central tax revenue in 2000-05.

Further, under the EFC, 29.5 per cent of the revenue receipts from income-tax, corporate tax, Customs, excise and other taxes would amount to Rs. 4,35,000 crores against the 29 per cent share of about Rs. 2,05,000 crores, an increase of about of Rs. 46,0 00 crores for a period of five years. In no time, this resource transfer will turn out to be inadequate and can only leave a greater surplus with the Centre, which is tantamount to the continued centralisation of resources. Therefore, as Dr. D. M. Nanjun dappa argues, looking at the Centre as the main player in federal financial relations and taking note of its responsibilities, especially that of Defence, it is suggested that the Centre should retain 50 per cent of the total revenue resources and transf er the remaining 50 per cent to the States.

In this rendering, all States put together would get a resource transfer equivalent to what the Centre retains as a single agency. The criteria to be adopted for distribution of the proceeds of the divisible pool is not the major issue. It is the composi tion of the divisible pool and the share that should go to the States that is of crucial significance.

From monolithic national party governance to multi-party coalition with regional dominance, is a new idiom in the political system 52 years after Independence. During this transformation and development, the Centre-State financial relation has undergone salient changes. There is no gainsaying that the ``gap-filling approach'' has been instrumental in creating the economic dualism -- developed States have become richer and the less developed ones poorer. Equally, the implications of the Eleventh Finance Commission will penalise the ``performing States'' and encourage the ``non-performing States''.

In all, including the Southern States, fiscal management should focus on reversing the rising trend in revenue deficit, widening and rationalising the States' tax base; augmenting tax revenues either through tax or non-tax measures, introducing the VAT s ystem; rationalising stamp and registration fees and uneconomic user charges in respect of power, transport and irrigation; enhancing the viability of public sector undertakings through better management and pricing policies; implementing expenditure ref orms measures through a progressive withdrawal of the States' from non-core sectors; phasing out the implicit subsidies, and transferring a greater proportion of shareable taxes from the Centre to the States. Above all, a comprehensive approach to the St ates financial reform is essential to have consistency in policy prescriptions and to implement sustainable economic reform initiated in the 1990s with the States' fiscal activism.(The author is a former professor of Economics, Voorhees College, Vellore. )