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Finance Commission

N K Singh

The eoncept,of Fimance Comlrnissiore is en-lh,edded .in tlae coiastirttlti,onal history of rfhis eountry. trm a serase, it is even lder tham our Constirlurtion. Tla.e ell,eh,ates of the C.onstituienrt AssembXy are repnete with instanccs of ditfferenees amrd ivergen-ce of opiniion ,om the rmodanities for the sharing of rt:he resoltrees betureera the lllni,on amd rttrre Staites. trrt is in thris e,onLtexrt that in lg4l9, ara inrterimr Finanee Comrmissiionx was appoirated r,lnd'er tnte cnrairmanship of C"D. Deshraaukla to eonsidren the tiistribution of resourees Jretween ttrre Uraion and tlae States.

he constitution of the Finance Commission is vertically between the Centre and states; and horizontally govemed by Arlicle 280 of the Constitution, among all states. Fifteenth Finance Commission was which spells out, in conjunction with other additionally tasked with reviewing and commenting provisions, the manner and modality for the on the design of flsca1 principles for various grants that management of the finances of the Union and the States are typically provided alongside revenue shares. It was as well as the principles for goveming the divisible also asked to consider performance-based incentives resources. After the interim Commission, the first Finance to supporl and motivate the efforls of State and/or local Commission was constituted on November 22, 195 I and gover-rrments-the "appropriate level of govemment"-in was chaired by K.C. Niyogi. Thereafter, there have been a variety of policy areas. Another unique ToR given to it fifteen Finance Commissions. I was privileged to be its included recommending funding mechanism for defence Chairman with four distinguished members. and internal security. The Fifteenth Finance Commission (FC-XV) was The Commission from its very conception faced constituted by the President under Article 280 of the multiple challenges including the difference in opinion on Constitution on November 2'7, 2011 . The title of the the use ofthe population census of2011 to allay the fears report 'Finance Commission in Covid Times', submitted of ceftain efflcient States that they r.vould be penalised for to the President for the period 2021-26, itself speaks efficient demographic management. Besides, there were of the onerous task it had in hand when the pandemic other issues like non-lapsable defence fund and use of had significantly impacted the economy and shrunk the cefiain parameters for performance incentives which have overall pie of resources. The Union government, in its been fairly addressed in this report. action taken report on the commission's report tabled The Finance Commission has been described as the in Parliament on February 1,2021 accepted most of the balancing wheel in the Constitution because it is designed recommendations. to correct the strucfural and inherent imbalances between 5 The Finance Commission transfers are made under the resources and the expenditure of the Union and o6ffi Articles 210, 275 and 280 of the Constitution, which the States. The conection of this imbalance would .ffiI.F provides a mechanism for sharing of taxes and revenues constitute the basis for a fair vertical devolution. r$*fn

The author is Senior Economist, Policy Adviser and Chairman, Fifteenth Finance Commission of India. Email: [email protected] * fTj.Er.:; -EcH|a;

-:j:iF,m9' !'ertical Transl'er: Approach and Logic The Constitution empowered both the Union and the States to raise revenues from different sources oftaxation and also assigned responsibilities to incur expenditure through subjects in three lists Union List, State List and Concurrent List in the Seventh Schedule. By Constitutional design, this distribution has assigned higher and more buoyant taxation and resource raising powers to the Union Government whereas higher responsibilities for incurring expendifure have been assigned to the States. For example, in 2018-19, the Union Government ruised 62.1 per cent of the aggregate resources raised by both the Union and States, whereas the States spefi 62.4 per cent of the aggregate expenditure of the Union and the States. There is thus a structural vertical imbalance expendifures. Additional flnancial resources are certainly which necessitates orderly transfer of resources from the needed to help a state develop, but the ability to effectively Union to the States. This imbalance between revenues use those resources is undoubtedly more crucial, and is a and expenditure responsibilities forms the basis of a fair distinctive feature visible across States. vertical devolution. Considering these factors, Fifteenth Finance The Fifteenth Finance Commission, in its final reporl, Commission has tried to harmonise the principles recommended this devolution to beat 41 per cent. This of expenditure needs, equity and performance in will maintain the predictability and stability of resources, determining the criteria for horizontal sharing by broadly especially during the pandemic. This verlical devolution is assigning appropriate weightages. The Commission has in line with the recommended share in our flrst report as given the criterion for horizontal distribution of taxes, well as with the devolution of the FC-XIV. As compared see Table 1. to FC-XIV this Commission has only made the required Table 1: Criterion Recommended by Fifteenth Finance adjustment of about 1 per cent due to the changed status Commission for Horizontal Distribution of Taxes of the erstwhile State of Jammu and Kashmir into the new Union Territories of Ladakh and Jammu and Kashmir, Criteria Weight ( per as the resources for these Union territories will now be cent) provided by the Union government. This level of vertical Population 15.0 transfers will allow appropriate fiscal space for the Union Area 15.0 as well to meet its demands as well as maintain an adequate level ofunconditional resources to the States. Forest & Ecology 10.0 Horizontal Distribution Income Distance 45.0 Horizontal devolution of taxes is mainly Tax & Fiscal Efforts 2.5 driven by considerations of need, equity Demographic Performance 12.5 performance. balancing equity and Howeveq 100 and efficiency is never an easy exercise. The diverse nature of this country As is clear from basic logic, population, area and . with States at different levels of forest and ecology represents the need-based principle, I development and having complex while income distance criterion represents an equity-based characteristics related to their principle. In addition to these criteria, this Commission has history geography, economy used tax and flscal efforls and demographic performance and sociology impact as a performance criterion to allay the fears of the more their revenues and efficient States in the country.

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Ln_Percapita e$timdted GSDP (2021-22)

Chart 1: Chart Depicting States with Per Capita GSDP and Per Capita Deyolution

It may be noted that all Finance Commissions since States in relation to such norms developed and applied to sixth one, used the population data of the 19'71 Census both revenue effort and desirable levels ofexpenditure and as per their ToR, while recommending their awards. thereafter recommend grants in specific sums. Fifteenth Finance Commission was mandated by its ToR The Commission has recommended five different to use the population data of the most recent Census, categories ofgrants: after four decades. This had issue of seriously changing the resource allocation to few States which may have a. Revenue deficit grants, rocked the boat beyond repair for some of them. Besides, b. Grants for local governments, a sudden use of the latest Census data will be unfair to c. Grants for disaster management, States which have performed well on the national objective d. Sector-specific grants, and of demographic management. At the same time, the ToR e. State-specificgrants. of this Commission, itself mandated us to incentivise to Similar grants have been recommended by States for the efforts and progress made in moving towards Commissions in the past. The overall size of the grants, as the replacement rate of population growth. Hence, use of a proportion of total transfers, varied from 26.1 per cent demographic performance as a criterion has addressed underthe Sixth Finance Commission (FC-VD to7.7 per cent these issues. under the FC-V[. FC-XV recommended Nevertheless, the allocations grants aggregating to Rs. 10,33,062 to States have been fairly equitable crore, which is 19.65 per cent of total as shown in Chart-l. The chart recommended transfers to States. depicting twenty States show that The Commission believed that we recommended relatively higher revenue deficit grants will allow States per capita tax devolution to States time to adjust to changes in the pattern of with lower per capita income. This tax devolution recommended by Finance clarifies that the overall allocation Commissions based on the evolving to States as recommended by the patterns of their assessed needs, ability Commission is progressive. and performance. Besides, grants-in-aid Grants-in-aid are more directly targeted and equalises the standards of basic social services to After the distribution of the net some extent. Some of these grants have proceeds of taxes, the second core been linked with performance-based function entrusted to the Finance criteria that seek to promote some sectors Commission is to determine the in furtherance of natiqnal goals. Also, principles which should govern attaching performance criteria to fiscal grants-in-aid, assess the needs of transfers may enhance transparency,

10 YO.IANA March 2021 accountability, provide feedback on improving policy fonnulation and irnplementation and lead to better monitoring of expenditures. dq* Rlw#tsll!(0l"rll0lA Rcr enue Dctirit (lranls It is evident that no fomula-based horizontal devolution can rneet thc needs of each of the twenty- eight States whosc cost disabilities and fiscal capabilities are so vastly different from each other. Therefore, the Commission has recommended an aliocation of 1.92 per cent ofthe gross revenue receipts ofthe Union as revenue deficit grants to specific States. The revenue deficit grants aggregate to Rs. 2,94,514 crore, with gradual tapering off during the award period. b. Local Government Grants l. Absence of timely recommendations of State Finance Commissions and suitable actions thereon, The total size of the grant to local govemments recon'rmended by the Comr.uission is Rs. 4,36,361 crore for 2. Lack of readily accessible and timely accounts, and the period 2021-26. Of these total grants, Rs. 8,000 crore 3. Inadequate mobilisation of property tax revenues. is performance-based grants for incubation of new cities Finance Commissions in the past have drawn attention and Rs. 450 crore is for shared municipal services. A surn to these issues, but with limited success. The FC-XV has of Rs. 2,36,805 crore is eanr-rarked for rural local bodies, put them as entry-level conditions for availing the grants. Rs. 1,21,055 crore for urban local bodies and Rs. 70,051 crore for health grants through local governments. Disaster N'l anagement Grants Urban local bodies have been categorised into two While assessing disaster management grants, the groups, bascd on population, and different norms have Commission recommended Mitigation Funds to be been used tbr flow of grants to each, based on their set up at both the national and State levels, in line with speciflc needs and aspirations. Basic grants are proposed the provisions of the Disaster Management Act. The only for cities/towns having a population of less than a Mitigation Fund should be used for those local level and million. For Million-Plus cities, 100 per cent of the grants community-based interventions which reduce risks and are perfbrmance-linked through the Million-Plus Cities promote environment-friendly settlements and livelihood Challenge Fund (MCF). practices. For SDRMF, it has recommended a total corpus 1,60,153 for States for disaster management For rural local bodies, the FC-XV allocations cover of Rs. crore for the duration ot 2021-26, of which the Union's share is all the three panchayati tiers village, block and district as Rs. 1,22,601 crore and States'share is Rs. 37,552 crore. weil as the Excluded Arcas exempted from the purview of Parl IX and Part IX-A of the Constitution. Othcr Sector-specific and Statc-specific Grants The rural-urban distribution Under the category of sector- gradually increases in t:lrour of the The Fifteentlr Finance specific grants, the Commission has urban local bodies from 67:33 rn2021' Commission was constituted also recommended performance- 22 to 65:35 by 2025-26. The tilt reflects tbr sectors by the President under Article based grants and incentives lndia's ongoing rapid urbanisation. The like health, education, agriculture, 280 of the Constitution on urban share oftotal population went up PMGSY roads, judiciary statistics and November 27, 2017. The from 28 per cent in 2001 to 31 per cent aspirational districts and blocks. in 2011 and is even higher now. title of the report 'Finance The Commission laid special The local bodies grants focus on Commission in Covid Times', focus on health sector while doing a national priorities. The grants to local submitted to the President detailed analysis of health expenditure bodies, both rural and urban (less than for the Beriod 2021-26, itself and related facilities and infrastructure a million catcgory). contain a mix speaks of the onerous task it in various States. The health sector of basic, tied as well as performance hand when pandemic cl.rallenges like grants such as sanitation, solid waste had in the still faces critical inter-State management and ease of breathing in had significantly impacted the low investment, sharp the metro cities. The efficient smooth economy and shrunk the overall variations in the availability of health health outcomes functioning and accountability of local pie of resources. infrastructure and bodies have been plagued by: and supply side problems of doctors,

YOJANA March 2021 t1

-r -r+ paramedics and inadequate number of healthcare revenue receipts by reducing its grants cotllponent by I per centres. Accordingly, it recommended total grants-in- cent. This will enable the Union to set aside resources for aid support to the health sector over the five year award the special funding mechanism that has been proposed in period aggregating to Rs.1,06,606 crore which is 10.3 the repofi. It has also been recommended that the Union per cent of the total grants-in-aid recommended by the Govemment may constitute in the Public Account of Commission. The Government of India, in its budget of India, a dedicated non-lapsable fund, Modemisation Fund 2021-22 has laid special emphasis on the health sector. for Defence and lnternal Security (MFDIS). The total Also, the Government in its action taken repofi, has indicative size of the proposed MFDIS over the period stated that it will take due consideration of these srants 2021-26 is Rs. 2,38,354 crore. This recommendation has while formulating centrally-sponsored schemes. been accepted by the goven-rment. principles A summary of all grants recommended by the The of a non-lapsable fund has been Commission are given in Table-2: accepted by the govemn.rent-this is an imporlant landmark considering that the delence forces have for Table-2 long argued in favour ofgreater stability and predictability S.N. Grant Components 2021-26 of finances for meeting their capital expenditure. The Commission has suggested a financing modality, which 1 Revenue Deficit Grants 2945t4 the central government will examine further. However, the ) Local Governments Grants 436361 constitution ola non-lapsable fund wouldmake a signifi cant difference in addressing the issue of adequacy of capital J. Disaster Management Grants t22601 expenditure both for deferrce and intemal security. In the 4. Sector-specific Grants t29981 formula given by the Finance Con.rmission, whereas Rs. Sectoral grants for Health 31755 40,000 crore per annum would be available for dcfence, Rs. 10,000 crore per annum would be available for home tl School Education 4800 ministry to upgrade paramilitary forces. Finally, Rs. 1,000 lu Higher Education 6143 crore per annum has been recommended as Jawan Welfare tv Implementation of Agricultural Reforms 45000 Fund given the enormous sacrifices of lndia's armed and paramilitary forces. V Maintenance of PMGSY Roads 275 39 Conclusion vt Judiciary t0425 While making its recommendations, the vn Statistics I175 Cornmission went through widespread stakeholder consultations vut Aspirational Districts and Blocks 3150 including Union Government, State governments, local 5. State-specific 49599 bodies, trade bodies, political parties and economists. It also took inputs Total 1033062 from experts through its advisory council, international and national organisations, think-tanks, high- All grants outlined in I -3 have been fully accepted in level group on health sector etc. As the Con.rmission faced the action taken report of the Union Government. Those the unprecedented challenge of making projections and in respect of sector-specific grants in the action taken recommendations under the most uncefiain circumstances. report would be subsumed under the centrally-sponsored it consistently tried to balance the views of these schemes or other initiatives of the central government. stakeholders to achieve efficient, equitable, inclusive It is significant in this context that the Finance Minister solutions in this extremely diverse country. announced that based the recommendations on of the Notwithstanding challenging times, the Commission Fifteenth Finance Commission, entire pattern, the believes that the distribution of resources between the allocation and design of the centrally-sponsored schemes Union and the States and for the third tier of government and the central outlays are being restructured to make have been addressed in a manner which is fair, reasonable, expenditure more pu{poseful. In respect of the state- rational and equitable. In this sense, indeed, it represents a specific grants, the action taken report indicates that continuation of the legacy of trust the trust which it has these would be given in-depth consideration based on the inherited from its very inception in a tentative way in 1949 availability of fi scal resources. with an unbroken record. Defence Fund It seeins apt to quote Marcus Aurelius, Meditations - Keeping in view the extant strategic requirements for 'Neyer let the ./uture disturb you. You will meet it, if ltott national defence in the global context, the Commission re- have to, with the same weapons oJ'reason whit:h today arm calibrated the relative shares of Union and States in sross you against the pre.sent.' D t2 YOJANA March 2021