Q.29 How have the recommendations of the 14th Finance Commission of India enabled the states to improve their fiscal position? GS-II: POLITY (UPSC CSE 2021) (150 words/10 marks)

Answer.

THE INTRODUCTION:

Finance Commission is constituted by the President under Article 280 of the Constitution. It is mainly constituted to give its recommendations on the distribution of tax revenues between the Union and the States and amongst the States themselves.

THE BODY:

• • The 14th Finance Commission recommended increasing the states’ share in the divisible pool of central taxes from 32% to 42%. It is the largest ever increase in vertical tax devolution. All states received at least 20% more funds from the central government.
  • The Commission adopted a comprehensive approach to horizontal distribution. It used multiple parameters of Population (2011 data), demographic changes, income distance between states, forest cover and geographical area. This framework particularly benefited poor states through the income distance criterion and States with significant forest cover through ecological considerations.
  • By providing more untied funds through higher tax devolution, states gained greater autonomy in designing and implementing schemes as per their needs. The Commission considered states’ entire revenue expenditure needs without plan-non plan distinction, enabling a more comprehensive view of state finances.
  • The Commission introduced a robust support system for local governments. Grants are divided between gram panchayats and municipalities. Basic and performance grants are divided in 90:10 ratio for panchayats and 80:20 for municipalities.
  • The commission increased allocations to State Disaster Response Funds (SDRF) and recommended a 10% annual increment to accommodate inflation. It changed the Centre- state contribution ratio to 75:25 for general states and 90:10 for special category States could better manage disaster-related expenditures without diverting funds from development projects.
  • The increased funds helped states reduce their revenue deficits. The commission suggested states to maintain a fiscal deficit of 3% of Gross State Domestic Product (GSDP). It allowed additional borrowing of 0.5% of GSDP for states with debt-to-GSDP ratios below 25% and interest payments below 10% of revenue receipts. States undertook measures to improve revenue generation and control expenditures. Gujarat maintained fiscal deficit targets, leading to improved credit ratings and attracting investments.
  • The commission recommended that borrowings should primarily fund capital expenditure, not revenue It encouraged states to fund revenue expenditure through revenue receipts, not borrowings.
  • The number of CSS was reduced from 66 to 28, but many schemes were merged under umbrella programs. States now have to contribute a larger share to CSS funding (40% for general category states, up from 25% earlier). The actual number of CSS is much higher than 28, as each scheme has multiple sub-components. Some states faced difficulties in maintaining the same level of expenditure on social sector schemes due to the reduced central funding. The “one-size-fits-all” approach of CSS was criticized for not addressing state-specific needs.
  • The implementation of GST in 2017 further impacted state finances. SGST revenue as a percentage of GSDP remains below pre-GST levels for many states. The discontinuation of GST compensation grants in June 2022 has adversely impacted some states.

THE CONCLUSION:

The increased tax devolution and revenue deficit grants provided states with more substantial financial resources, directly aiding in reducing revenue deficits. Incentives for fiscal discipline and expenditure rationalization encouraged states to manage their finances more effectively, focusing on sustainability.