Chairman of the 15th Finance Commission N K Singh backs the government’s position on Andhra, blames ‘mismatch’ between banking functions for the PNB fraud, calls for interactions between RBI and MPs, asserts GST will have a beneficial impact on direct taxes, and explains 42% share of states in Centre’s tax revenue
RAVISH TIWARI: With the Centre ruling out ‘special status’ for Andhra Pradesh, the TDP has pulled out its ministers from the government. Can the 15th Finance Commission make different categories for states?
First of all, the Finance Commission’s work must emanate and end with its obligations contained in the ‘terms of reference’, which are determined by the President on the advice of the Council of Ministers. Apart from the classic functions, there is another provision in the Constitution, which says the commission can (look into) ‘any other issue referred to it by the President’. In the present case, as with earlier commissions too, a number of issues have been referred to us. They fall into two baskets. First are those issues the commission may like to bear in mind while making recommendations. For example, the success achieved on population replacement rates, flagship programmes of the government, suggesting a fiscal and macro roadmap of consolidated fiscal strategy etc.
Under the second category we could consider the measurable performance-based incentives in respect to states, which could deal with the ease of doing business, promoting labour-intensive industries, promoting sanitation, ending open defecation, success achieved in flagship programmes… Once we can evolve measurable performance-based incentives, we can consider whether we would like to give incentives. These are classic and added functions of the commission as given to us by the President. Our obligation is to discharge these and to give recommendations on horizontal and vertical distribution of resources — distribution to local bodies, panchayats, zilla parishads — to consider issues, to suggest or not to suggest grants-in-aid to states, and to look at the measurable performance-based incentives. An interesting measure in performance criteria is the extent to which states have been indulging in populist expenditure. We are trying to find out what this would mean.
Now, within this framework, where does Andhra’s demand for a special category status figure or not figure? Firstly, the previous commission abolished the special category status and said that it was not appropriate to categorise states into ‘special’ and ‘non-special’, and that they should be treated in a ‘general’ way. The issues of states which need special attention could be addressed through other measures and means the commission has at its disposal.
The special category issue is not based on the specific ‘terms of reference’, but (the previous commission) did pronounce that these categorisations had outlived their utility and that it is not the most appropriate path forward.
And, I have learned from newspapers that the Finance Minister has said that the government has accepted recommendations of the 14th Finance Commmission to eliminate all categorisations, and acted accordingly. That is the end of the matter. (The Finance Minister had said that the Centre was willing to provide the ‘monetary equivalent’ of a special-category state to Andhra Pradesh but would not be able to grant it ‘special status’, which was restricted only to the Northeastern and three hill states by the 14th Finance Commission.)
RAVISH TIWARI: The Centre is using the recommendations of the 14th Finance Commission as a shield, and the TDP is using the same as a punching bag. How do you look at this conflict between the Centre and state?
Our job is neither to provide a shield nor to provide the basis for a punching bag. It would be an exaggeration to suggest that the Centre is using this as a shield. They have accepted the recommendations of the previous commission in totality and one of the recommendations was to eliminate all artificial categorisations. The government is just stating facts, and the fact is that the previous commission said that these categorisations are artificial, and along with the other awards of the commission, the government has also accepted this particular recommendation.
Let me demystify what special category status means. It has two features: It gives you a tax break, typically for 10 years, with a sunset clause, freedom from excise and income and corporate tax, which in turn becomes a way to attract more industries. The other aspect is with respect to Centrally sponsored schemes (CSS). Normally, the Centre and state shared (the funding) on a 70:30 basis, which was later changed to 60:40. In CSS, for special category states, the ratio is 90:10. This gives such states greater fiscal headroom and more resources. It was originally conceived for J&K and then extended to the Northeast. Later, Atal Bihari Vajpayee announced it for Uttarakhand and Himachal Pradesh.
(The move to abolish categories) couldn’t have been done retrospectively because many of the states that are enjoying its benefits have set up plans. So the sunset clause is being allowed to wear out, if not extended. But the previous commission did say that further categorisation was not appropriate, and should be dealt with by providing assistance in other forms.
Now, what does the 15th Commission intend to do? I intend to address my ‘terms of reference’, and this (categorisation of states) is not part of those terms of reference. But what is part of the terms is to look at equitable regional growth. This means that, like all commissions, we will look into the extent to which some states are below the average of national per capital income, and see whether they have received special attention.
The special category status, with respect to very backward states, is one of the means to enable them to catch up with the national average. But the issue before us is not special category states, but to address the ‘terms of reference’. And, one of the areas in the terms is fostering equitable and balanced regional development, and we will look at the index and levels of backwardness of different states. Instruments are not just tax breaks but other parameters such as backwardness, population etc, which will be used to incentivise states.
HARISH DAMODARAN: Wouldn’t doing away with incentives such as excise exemptions drive more investment to already developed parts of states — to Ahmedabad-Mehsana instead of Kutch in Gujarat or to Bengaluru rather than to Belgaum in Karnataka? Can we leave everything to the market forces?
Firstly, I did not say we will not consider it or that there is no scope for considering any of that. We have the mandate and authority to revisit anything which has been visited earlier. This commission is not bound by anything but the ‘terms of reference.’ So it is perfectly up to us what we wish to visit and revisit and come to conclusions which we consider appropriate.
Secondly, there are some states which fall below the national averages in terms of well-accepted characteristics of backwardness. Every commission has given a certain weightage to ameliorate the backwardness of such states by way of hard devolution. The 14th Commission has given high weightage to the index of backwardness. There are instruments available — in terms of direct devolution of additional financial resources to states, either by devolution or by grants and aid — and unless you employ them, there is nothing very much you can do to ameliorate the condition of such a state.
K G NARENDRANATH: A reason why states’ share in divisible pool of taxes increased over the last few finance commissions was that direct taxes, which states have little powers on, were a major part of the pool. The trend in the last few years is that of an accelerated growth in indirect taxes, and the GST is expected to buttress this trend. So does that make a case for a cut in states’ share in the divisible pool now? Also, there is the issue of indirect taxes being regressive in nature.
First of all, I haven’t reached any such conclusion. Historically, India is one of those countries where a very disproportionate part of the revenue has come from indirect taxes. The petroleum sector constituted the highest component of those indirect taxes — and that is something a developed economy should move away from; indirect taxes are regressive because they do not differentiate between the rich and poor.
We should move to greater reliance on direct taxes. The GST has taken care of excise, VAT. That only leaves Customs duty on the indirect tax side. Customs duty over time has to calibrate to long-term global average to promote international trade. Countries can go through the process of change for a year or two, but over time, reliance on Customs will come down, because the gains will come from much larger volume of international trade, and not Customs duty.
So yes, the direct tax to GDP really needs to go up substantially. The big problem is of exemptions and enforcement. Look at the number of people who are declaring incomes of more than Rs 1 crore in India as a whole. It is a laughable number. But all that is changing, technology is bringing about a fundamental change.
Also, as a huge number of people come under the GST net, many who did not pay direct tax will now be paying them. The GST net will have a beneficial impact on direct taxes. But the exemptions on direct taxes have to come down significantly.
At the same time, in that exemption, is the complex issue of the entire agricultural sector, which is outside the tax net. Even though agriculture may constitute just 12 per cent of the GDP, 45-50 per cent people are deriving their livelihood from it. You can argue that they are poor people, but the view that every agriculturist is a very poor man is something which needs to be… But that’s a state subject.
Then the enforcement quality needs to be dramatically improved. We are now using technology much more intensively and extensively. There is 360 degree profiling, capturing all big data via the GST etc.
Service tax, which didn’t exist some time ago, is showing the highest amount of buoyancy, which is inevitable in an economy going through this phase of progress.
K G NARENDRANATH: A multi-dimensional backwardness index was earlier proposed by the Raghuram Rajan committee and it was expected to address the resource constraints of states that are far below national average in terms of key development indicators. If you give adequate weight to such index, then won’t the special category status become redundant?
I have seen the Rajan committee’s compilation of index, and at the bottom of that index are the states of Odisha and Bihar. But we will be looking at fresh data and getting more studies done on the index of backwardness, by doing simulation and econometric analysis etc.
ANIL SASI: The 14th Finance Commission raised the share of states in the Centre’s tax revenue to 42 per cent for a five-year period starting 2015-16, up from 32 per cent earlier. Is there a case to revisit that number and to re-examine the increasing use of cess and surcharges as revenue-raising tools by the Centre?
Is there a case to revisit the 42 per cent number? I don’t know whether there is a case or not. That is a conclusion that the commission will have to reach at the end of its deliberations. But yes, it is part of the terms of reference and the 14th Finance Commission itself is part of the terms of reference. We will certainly need to examine and consider it.
Also, we will need to examine the overall framework. The 14th Finance Commission’s recommendation is not just limited to 42 per cent. It is much more. I will just explain that. The recommendations came in the backdrop of the rationalisation of the CSS. The philosophy was to give them (the states) much higher resources. Allow them to do whatever they want to with that resource.
Now, shortly after, there was the Shivraj Singh Chouhan report on the CSS. (In March 2015, a panel headed by the Madhya Pradesh Chief Minister was constituted to recommend a funding pattern for the CSS). In truth, what has happened is that a lot of the financial burden of the CSS is being shared, in some form or the other with varied proportionality (the same way as before). And the index of happiness on the CSS has certainly not gone up exponentially. States are unhappy that you have changed this financial burden-sharing formula, the Central government is not very happy to say that we are continuing with that burden, but we don’t have the resources to be able to do so. So, I think, we should compile an index of satisfaction on the CSS. That is one of the things that the commission has to do.
On the 42 per cent formula, what has not come out so much in the public domain is that the 42 per cent leaves out (the funds) given separately for the panchayats, for the local bodies and Vidhan Parishads. And, the previous finance commission increased that substantially. If you add all this and the grants under Article 275 (provided from the Consolidated Fund of India to the states), it comes close to 47.5 or 48 per cent. So 42 per cent is the direct devolution.
(On cesses and surcharges) It is a legal and constitutional question. But since cesses and surcharges are so much now in the public domain, we will certainly get an independent study done on that. (On March 1, The Indian Express reported that the 15th Finance Commission is expected to commission a study on the legality of the use of these levies.)
RAVISH TIWARI: Who do you think is at fault for the recent Punjab National Bank fraud? Do you think the regulator too has been caught on the wrong foot?
The technical reason for this fraud is a very simply one. It is because of a mismatch between SWIFT with the core banking functions. The fact that six audit functions within the bank could not really place their hands on this kind of an irregularity doesn’t speak well for the governance ethos of the bank in question. It also raises questions about the governance fabric of some of the other banks that apparently got affected.
The second component is the regulator. The Reserve Bank of India is the bank regulator. In 1991, it was suggested by the Narasimhan Committee (for Banking Reforms) that a separate entity be created within the RBI itself, which has the domain knowledge and expertise to be able to do detailed supervision, like an ombudsman.
In my view, the path to be followed is two-fold: one to fully implement in letter and spirit the Narasimhan Committee report in having a robust entity within the RBI with adequate manpower. The second is to keep your mind open to whether or not you require a super regulator and who that super regulator would be. Finally, I think that one of the areas in which India has been very deficient has been in parliamentary superintendence on the working of the regulator.
On how many occasions does the governor of the Central bank have interactive meeting with parliamentarians? Zero. He will be called to give depositions at the Public Accounts Committee on demonetisation. In light of the PNB fraud, he will be asked by the parliamentary standing committee to come. This is not regular interaction.
So, we have not allowed our regulators to face the burden of parliamentary superintendence. But the issue is who will regulate the regulators? When you create an independent regulator by a separate Act of Parliament, and if Parliament does not exercise superintendence functions in some way on the regulators, you have created a no man’s territory. We can create, let’s say, one or two parliamentary committees, which really are for the purpose of interaction with regulators.
RAVISH TIWARI: The 15th Finance Commission launched its national-level interactions from Arunachal Pradesh. Coming to the other ‘A’, what do you expect to encounter when you arrive in Andhra Pradesh?
We have started with Arunachal Pradesh and the next state will be J&K. We are looking forward to interactive visits to all 29 states. We will not just meet people in the government but also members of all political parties, other stakeholders, panchayat representatives, municipalities, academic bodies etc. We are holding fairly wide-ranging consultations before making our recommendations.
Now what welcome or un-welcome I expect in Andhra Pradesh, we will cross the bridge when we come to it. The memorandum should be for us to revisit some issues that have been visited earlier. We will take into account all submissions made to us, either on behalf of the states, on behalf of organisations, on behalf of the Finance Ministry of the Central government… Only then will we arrive at what we believe would be appropriate conclusions. And the independence of the Finance Commission would be something that I definitely want to underscore.