In their suggestions to the 16th Finance Commission (FC), several states have argued in favour of increasing their share in the divisible tax pool. Some have even called for raising the states’ share all the way up to 50 per cent from the current 41 per cent.
States do have a right to feel aggrieved. After all, even as the 14th FC increased their share in the tax pool to 42 per cent, and the 15th FC keeps it at 41 per cent (reducing it by 1 per cent with J&K becoming a Union territory), the central government reduced the divisible tax pool itself. It did so by imposing cesses and surcharges, revenue from which is not shared with the states. By 2021-22, the divisible tax pool had shrunk to 78.9 per cent of the Centre’s gross tax revenues, from 88.6 per cent in 2011-12, as per the RBI. Thus, states have, on average, received only 32 per cent of gross tax revenues over the past six years.
The question then is: Should the finance commission accept their demand, and alongside, impose a limit on the cesses and surcharges that can be levied? This is not an unjustified demand. However, there are several issues to consider.
One, considering the demands on the Centre’s budget, it will be fiscally challenging for it if overall transfers to states are increased further. States already spend around 60 per cent of general government expenditure. Thus, the states’ demand for greater fiscal autonomy could be met by increasing the share of untied transfers. This would mean that within the current level of transfers from the Centre, the composition of tied and untied funds needs to be reworked, which would require rationalising centrally-sponsored schemes. This, however, is tricky terrain.
Driven by political considerations and/or the imperatives of economic development, successive Union governments have, through centrally-sponsored schemes, increased spending on items that fall in the state and concurrent lists. This has taken place despite grants to the states exceeding the Centre’s revenue deficit, effectively implying that it is borrowing to transfer to the states. This calls for a re-examination of the Centre’s expenditure priorities, which would create the fiscal space for it to spend on items on the Union list. However, political considerations may trump it, leading to a cash-strapped Centre sequestering revenue to fund its spending.
The demand for an increase in untied transfers also raises questions over the quality of spending. Revenue balances are worsening in a number of states, implying that state governments are borrowing more to spend on the daily functioning of government departments and services, interest payments and subsidies, and not for productive purposes. Even states like Karnataka have slipped into a revenue deficit. A high revenue deficit, which is driving the fiscal deficit in a state like Punjab, acts as a major constraint on capital spending from own resources. So, will more untied transfers create the space for higher allocations for revenue expenditure, perhaps on non-merit subsidies like power and water?
The last few years have also witnessed a flurry of cash-transfer schemes. As per a report from Axis Bank, 14 states have announced income transfer schemes, adding up to 0.6 per cent of the GDP. One could well argue that India is moving towards some form of quasi-universal income transfer. These cash transfers are being financed through a combination of expenditure switching and higher borrowings. Given the allure of such schemes and the compulsions of the electoral cycle, will greater untied transfers lead to more resources being diverted towards such avenues?
Moreover, what will a rebalancing of tied and untied transfers do for the equitable and comparable delivery of public services across the country? Considering the level of inequality — Bihar’s spending is way below that of higher income states — will increasing untied funds lead to a convergence? Will it help address the growing inter and intra state inequality?
Lastly, will an increase in untied transfers lead states to being more inclined to increase devolution to the third tier of the government? The third tier in India accounts for a considerably lower share of government spending when compared to countries such as China and South Africa (see Accelerating India’s Development). While, this is, in part, due to the constitutional framework, most states themselves are guilty of restricting devolution of functions and resources to the third tier.
The finance commission should look into these issues as it moves towards finalising its recommendations.
ishan.bakshi@expressindia.com
