Last week, the Union cabinet passed an amendment to widen the terms of reference of the 15th Finance Commission. The Commission has now been asked to examine the possibility of setting up a mechanism for funding defence and internal security. As capital spending on defence continues to fall well short of what is required, it is difficult to contest the premise that it needs to be bolstered. But, as the creation of “secure and non-lapsable funds for defence and internal security” may end up reducing the divisible tax pool further, the move could face resistance from states, especially when several of them are arguing for a greater share in tax revenues. While the commission is yet to spell out its views on the subject, this request raises fundamental questions over the spending priorities of different levels of government and the framework that governs Centre-state fiscal relations.
The Seventh Schedule of the Indian Constitution specifies the separate as well as concurrent responsibilities of the Centre and state governments, with defence falling in the Union list. The inability of the Centre to ramp up its spending on defence indicates the limited fiscal space available to it. In large part, this is due to an increase in spending on items in the state and concurrent list, and a corresponding decline in spending on items in the Union list. In 2015-16 alone, the Centre spent 16 per cent of its revenue expenditure on items in the state list, and another 16.4 per cent on items in the concurrent list. Now, some of this spending on items in the state and concurrent list is necessary. In a federal structure, the Centre must address regional imbalances in the delivery of public services. But the bulk of this spending is routed through sector-specific transfers or centrally sponsored schemes that curb the autonomy of the states in deciding their own expenditure priorities. The added fiscal pressures on the Centre have, in turn, contributed to reduced fiscal space for states. Over the years, the Centre has begun to rely increasingly on taxes collected through cesses and surcharges to meet its expenditure priorities. But revenue from these sources does not form part of the divisible tax pool, it is not shared with states — squeezing them from both ends.
While the compulsions of the political economy have ensured greater central government spending on items in the state and concurrent lists, the current juncture may well be an opportune moment to rethink the spending priorities of different levels of the government. There is a need, particularly, to address legitimate concerns of states about increasing encroachment by the Centre.