The Hindu Business Line : State of imbalance

The States’ concerns should be addressed not merely on grounds of equity, but also because it makes economic sense to keep their borrowings to a minimum.

Public attention in recent times has focused largely on the initiatives of the Central Government in stimulating economic activity, but the other leg of the policy framework — shoring up State finances — has not got the attention it deserves. The Union Budget, far from projecting an increase in the quantum of tax revenues transferred to the States, actually indicates a marginal decline in the current fiscal. Even the reduced quantum may not materialise if th e Central tax collections fall short of the Budget estimate — a distinct possibility. To compound matters, the buoyancy in value-added tax collections of the States has shown signs of flagging, the growth rate registering a sharp fall in 2008-09 at 19 per cent, compared to the 24 per cent recorded last year. The only silver lining for the States is the prospect of a higher devolution of Central resources by way of grants, although that depends on the performance of the economy and the willingness of the Central Government to sustain it through higher deficit financing should the anticipated recovery in the economy not kick in.

Another worrisome feature is the decline, in real terms, of the Central financial assistance to capital formation at the State level since 2004-05. Fixed capital formation with its emphasis on tangible asset creation reinforces a government’s ability to generate resources in the future through its own efforts. In this scenario, States will have no option other than to borrow from the market, adding to the ‘crowding out’ effect that is likely to arise from the Centre’s own borrowings— assuming, that is, there is at all a public appetite for such loan offerings from States that are fiscally challenged.

The Thirteenth Finance Commission has its task cut out. There are no easy options before it. It can, for instance, propose that the Centre share non-tax receipts with the States. Alternatively, it can revise upwards the proportion of such tax revenues it shares with the States, currently 30.5 per cent of the total. Both these options are certain to worsen the already precarious state of Central finances. Despite the inadequate transfer of resources, States account for the bulk of public spending. The Centre has been loathe to trim the size of its own spending — an attitude that has only been reinforced by the fact that there is a sharp dichotomy in the political composition. The Congress party, the dominant player at the Centre, has over the years, been reduced to playing only a marginal role at the State level. The States’ concerns should be addressed not merely on grounds of equity, but also because it makes economic sense to keep their borrowings to a minimum. Besides, States will be more amenable to a goods and services tax regime, which entails lowering and rationalising rates, if structural issues are addressed at the earliest.

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