The Constitution of India obliges the President (i.e. the central government) to appoint, every five years, a Finance Commission (Article 280). Its foremost duty is “to make recommendations to the President as to the distribution between the Union and the states of the net proceeds of taxes which are to be… divided between them… and the allocation between the states of the respective shares of such proceeds”.
There are other duties, but they are not germane to the controversy dealt with in this essay.
On the first part of the duty mentioned above (in italics), the states are together: they demand a greater share of the taxes from every Finance Commission (FC). As per the last FC (the Fourteenth), the states’ share was fixed as 42 per cent.
It is on the second part mentioned above — allocation between the states of the respective shares — that a controversy has erupted. Every state wants a larger share of the pie, but the total cannot exceed 100 per cent (of the 42 per cent). It is also not possible to freeze the respective shares of the states because the objective conditions for allocation of the respective shares may, and would, have changed in five years. If a state’s share is reduced even by a fraction, the state is unhappy. Every FC has an unenviable task, but none more than the Fifteenth FC that was constituted in November 2017.
The reason lies in the Terms of Reference (ToR) of the Fifteenth FC. The main terms of reference remain on the usual lines, but there are two significant departures from the past.
Firstly, the Fifteenth FC has been asked to consider certain performance-based incentives, including —
- efforts and progress made in moving towards replacement rate of population growth;
- implementation of schemes of the Government of India;
- control in incurring expenditure on populist measures.
Secondly, the FC shall use population data from the 2011 Census and not the 1971 Census that was used hitherto. Both changes are big changes that have serious implications for Centre-states relations. Structurally, the Constitution gives more powers of taxation to the Centre and more responsibilities of expenditure to the states.
Hence the need for a fair system of sharing the Centre’s net tax revenues. A state legislature has as much power over the state’s budget as Parliament has over the Union Budget. The FC is not a mechanism to impose the will — or the schemes — of the Central government on the states. Constitutionally, a state is entitled to say ‘give me my fair share of taxes and leave me alone to act according to the decisions of my state legislature’.
The second change is highly controversial. Hitherto, the population data was taken from the 1971 Census. The ‘freeze’ was agreed upon to protect the states that had done well in stabilising their population. The Fourteenth FC made a small shift: it reduced the weightage to the 1971 Census data from 25 to 17.5 per cent and introduced a weightage of 10 per cent to the 2011 Census data. Directing the Fifteenth FC to discard the 1971 Census data and take into account only the 2011 Census data, is a clear punishment for states that had performed splendidly between 1971 and 2011 in stabilising their population.
The argument that poorer states with less fiscal capacity, less revenues, historical disadvantages and poorer development outcomes deserve more support is a sound argument. It was acknowledged by the Fourteenth FC when it raised the weightage given to ‘fiscal capacity’ from 47.5 to 50 per cent — the highest for any factor. However, shifting the population data from the 1971 Census to the 2011 Census cannot be justified: in fact, it is a perverse incentive to states that had neglected to stabilise their population.
Better-governed and better-performing states have already lost crucial fractions in their shares (see table):
Douse the fire now
The southern states have lost 6.338 per cent on account of better governance and better outcomes, but they were at least protected against the consequences of a fall in their share of India’s population. According to the 1971 Census, their population was 24.7 per cent of the total population; according to the 2011 Census data it had fallen to 20.7 per cent. If all other factors are kept constant, the mandate to the Fifteenth FC to consider the population according to Post-1991, every state could take advantage of a more open economy, less control and state-specific strategies.
States that were once regarded as having low potential now claim to have achieved high growth rates. the 2011 Census will further, reduce the shares of the southern states. We may empathise with the states that are relatively poorer, but we cannot ignore the rights and aspirations of the better-performing states.
The central government has lit a fire. It should be doused before the southern flames scorch the federation.
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