In February 2015, when the government accepted the recommendations of the 14th Finance Commission, which recommended a record increase in the devolution of the Centre’s divisible pool of taxes from 32 per cent to 42 per cent, reactions in the government and the commentariat were celebratory. The government packaged it as a giant step for cooperative federalism, and a move away from the past when the Planning Commission and fiscal managers in Delhi sat in judgment over the resource needs and development plans of states.
The Planning Commission had been replaced with the NITI Aayog, and the dominant theme was Team India, a grand federation of states. Prime Minister Narendra Modi wrote to Chief Ministers, highlighting his government’s efforts to strengthen the country’s federal polity, and sending out the message that federalism was the only way to achieve rapid and inclusive growth, and strong states could be the foundation of a strong India. He then went to say that while the Centre had “wholeheartedly accepted the recommendations of the 14th Finance Commission”, they “put tremendous strain on the Centre’s finances… However, we have taken the recommendations of the 14th Finance Commission in a positive spirit as they strengthen your hands in designing and implementing schemes as per your priorities and needs.” This, the PM said, would help states move away from rigid central planning, and a one-size-fits-all approach.
Now, as the 15th Finance Commission headed by N K Singh prepares to begin work, its terms of reference suggest that the celebrations of 2015 were possibly premature. The primary remit of a Finance Commission is to work out the distribution of the net proceeds of taxes between the states and the central government, and the allocation among states. Post-1991, successive Finance Commissions have been asked by the President to review the fiscal discipline efforts of the federal and state governments, and their debt levels, and to suggest prudent ways of managing their finances. This Commission has been mandated to recommend a fiscal consolidation roadmap for sound fiscal management, taking into account the responsibility of the central and state governments to adhere to appropriate levels of general and consolidated debt and deficit levels, while fostering higher inclusive growth in the country, guided by the principles of equity, efficiency and transparency.
This is something that a previous Commission, too, had been asked to work on. But there is a hint in one of the terms of reference that the higher devolution of 42% recommended by the 14th Finance Commission may well have to be reconsidered. The 15th Commission will look at the “impact on the fiscal situation of the Union Government of substantially enhanced tax devolution to states following the recommendations of the 14th Finance Commission, coupled with the continuing imperative of the national development programme including New India, 2022”.
This is as good as saying that the Centre has been hamstrung by the greater flow of resources to states following the award of the 14th Commission, and after implementation of GST. And interestingly, post-2015, even after the greater flow of resources, in a slowing economy, the fiscal deficit of states, which, on a combined basis, was far better than the federal government, started sliding — while that of the Centre, which was 4.1% of GDP in 2014-15, started reversing.
Reining in states on fiscal consolidation will thus be a goal. From a political perspective, it may have struck many in the government that the elbow room to spend extra in the face of the slowdown without breaching mandated deficit levels had been severely restricted — even as the blame for economic management continued to be assigned to the union government. (Indeed, the Centre’s finances would have been in bad shape if not for the windfall from oil; the government raised Rs 1,50,000 crore through higher excise duty.) This Commission will be tested on how it re-works the record devolution recommended by its predecessor panel. In fact, C Rangarajan, who headed the 12th Finance Commission, had in the past suggested a constitutional cap on the size of devolution.
Chief Economic Adviser Arvind Subramanian, writing in the Business Standard in February 2015 with his colleagues Syed Zubair Naqvi and Kapil Patidar, had said that the recommendations of the 14th Commission had the potential to redefine Indian federalism. The authors had also flagged challenges of the transition — notably on how the Centre would meet its multiple objectives, given the shrunken fiscal leeway.
This Commission could get into tricky territory — politically and otherwise — on measurable performance-based incentives for states: say, for expanding and deepening the tax net under GST, boosting tax and non-tax revenues, promoting savings by adopting direct benefit transfers, promoting digital economy, removing layers between the government and beneficiaries, making strides in sanitation, solid waste management and behavioural changes, eliminating losses in the power sector, and improving the ease of doing business. However, proposing a measurable performance-based incentive on the “control or lack of it in incurring expenditure on populist measures”, is bound to raise questions on whether it challenges the spirit of federalism. It would mean defining a “populist scheme”, and whether spending on social welfare by a democratically elected state government can be penalised. It will also lead to questions on the nature of schemes being run by the central government — some of which can be seen as “populist” as well.
In his memoir, Advice & Dissent: My Life In Public Service, Y V Reddy, Chairman of the last Finance Commission, wrote that new economic realities, including globalisation, may warrant greater involvement of the union government in many ways, but they did not necessarily justify intrusion into the legitimate fiscal space of states accorded by the letter and spirit of the Constitution.
In his letter to CMs, Modi wrote that his government believed that “states should be allowed to chalk out their programmes and schemes with greater financial strength and autonomy, while observing financial prudence and discipline”. How the 15th Commission goes about this task would describe the difference between cooperative federalism and “coercive federalism”.