THE CONTEXT: The debate surrounding Kerala’s protest of the Centre’s imposition of a Net Borrowing Ceiling (NBC) underscores a growing concern over the erosion of fiscal federalism in India. This brings into the limelight the conflict between the constitutional autonomy of states to manage their finances and the Centre’s regulatory mechanisms intended to ensure fiscal discipline and transparency.

THE ISSUES:

• Net Borrowing Ceiling (NBC): The NBC is a limit set by the Centre on the total amount that states can borrow from all sources, including open market operations and loans from state-owned enterprises. Specific to Kerala, the NBC now includes debts incurred by the Kerala Infrastructure Investment Fund Board (KIIFB), which funds infrastructure projects through extra-budgetary routes. Including KIIFB’s debts under the NBC restricts Kerala’s financial autonomy, directly impacting its ability to fund welfare schemes and pensions.
• Constitutional Limits and Fiscal Federalism: Article 293(3) requires states to seek the Centre’s permission to borrow if they have any outstanding federal loans. The imposition of the NBC by the Centre is under this article, which Kerala contends is a violation. Kerala’s legal stance to move to the Supreme Court suggests that the Centre’s decision infringes on the state’s constitutional rights to manage its public debt (Entry 43, State List) and public accounts (Article 266(2)).
• State Fiscal Responsibility and Transparency: Kerala Fiscal Responsibility Act, 2003 mandates reducing the fiscal deficit to 3% of Kerala’s Gross State Domestic Product (GSDP) by 2025-26. Kerala’s fiscal deficit has been reported at 2.44% and the revenue deficit at 0.88% of the GSDP, indicating a responsible fiscal approach compared to the Centre’s fiscal deficit, pegged at 5.8% for 2023-24.
• Impact on Governance and Welfare Implications: The restricted borrowing capacity directly impacts the state’s social obligations, such as funding pensions and welfare programs essential for balanced socio-economic development. The KIIFB’s innovative financial strategy for infrastructure development in Kerala is a model of how state autonomy can be effectively utilized for the public good, which NBC hinders.
• Assessment of Federal Dynamics: The shift in Federal Structure by transitioning from cooperative federalism towards a more ‘annihilative federalism,’ where the Centre’s stringent controls over state finances limit the states’ operational independence. Examination of this shift in India’s federal structure reflects on the long-term implications on centre-state relations and the principle of subsidiarity.
• Borrowing Restrictions: The 15th Finance Commission recommended that 41% of the net proceeds of Union taxes be shared with the states. However, the Centre’s decision to include off-budget borrowings done by states while deciding their borrowing limits led to a sharp decrease in such borrowings. This has been seen as a restriction on states’ ability to borrow and manage their finances, with Kerala particularly affected due to the inclusion of the debt of KIIFB in the NBC.

THE WAY FORWARD:

• Seek Judicial Clarification: Given that Kerala has moved the Supreme Court on the matter, one solution is a judicial review of the constitutional validity of the NBC with respect to Article 293(3) and Article 266(2). The Court’s interpretation could resolve disputes regarding the constitutional limits of the Centre’s authority over state borrowing.
• Review of 15th Finance Commission Recommendations: The issues stemming from interpreting the 15th Finance Commission’s recommendations could be re-examined. States can engage with the Finance Commission or the Union Finance Ministry to advocate their concerns and seek a more nuanced approach that doesn’t infringe on states’ fiscal autonomy while upholding fiscal sustainability.
• Legislative Action: Parliament could consider enacting legislation or amending existing laws (subject to constitutional limits) to clarify the scope of central oversight on state borrowings. This should respect the balance of fiscal federalism and be designed after extensive consultations with states.
• Strengthen Cooperative Federalism: Regular high-level meetings between the Centre and States, through forums like the GST Council or a specially convened fiscal policy council, could help facilitate dialogue. These meetings would aim to negotiate borrowing limits and ensure that states have enough financial leeway to meet their obligations.
• Promote Fiscal Responsibility at the State Level: States can take proactive steps to strengthen their fiscal management, as Kerala has done through the Kerala Fiscal Responsibility Act. By setting clear deficit targets and budget management practices, states can demonstrate their commitment to fiscal prudence, potentially increasing their negotiating power with the Centre.
• Build a Consensus on Public Account Handling: The issue of including public account withdrawals within the NBC could be addressed by building a broader consensus among all states, which can then be presented to the Centre in a united front to exclude such transactions from the borrowing limits.
• Economic Reforms and Growth Promotion: Widening the tax base through economic reforms, boosting the investment climate, and promoting growth in the state’s own-source revenue can be sustainable ways of ensuring sufficient funds for state spending without reliance on borrowings.

THE CONCLUSION:

Kerala’s challenge against the Centre’s Net Borrowing Ceiling (NBC) imposition highlights a significant constitutional dispute over fiscal federalism and state autonomy in financial management. The state argues that the Centre’s restrictions on borrowing, including debts of state-owned enterprises and public account balances, infringe upon its constitutional rights. This legal battle underscores the tension between central oversight and state fiscal independence, potentially reshaping the dynamics of federal-state financial relations in India.

UPSC PAST YEAR QUESTION:

Q.1 Though the federal principle is dominant in our Constitution and that principle is one of its basic features, but it is equally true that federalism under the Indian Constitution leans in favour of a strong Centre, a feature that militates against the concept of strong federalism. Discuss. (2014)

Q.2 The concept of cooperative federalism has been increasingly emphasized in recent years. Highlight the drawbacks in the existing structure and the extent to which cooperative federalism would answer the shortcomings. (2015)

Q.3 How far do you think cooperation, competition, and confrontation have shaped the nature of federation in India? Cite some recent examples to validate your answer. (2020)

Q.4 Public expenditure management was a challenge to India’s government in the context of budget-making during the post-liberalization period. Clarify it. (2019)

Q.5 What are the reasons for introducing the Fiscal Responsibility and Budget Management (FRBM) Act, 2003? Discuss its salient features and their effectiveness critically. (2013)

MAINS PRACTICE QUESTION:

Q.1 Critically examine the contention between the State of Kerala and the Centre over the imposition of a Net Borrowing Ceiling (NBC) concerning Article 293(3) of the Indian Constitution. Analyze the implications of such a ceiling on fiscal federalism and state autonomy, along with its potential impact on state welfare schemes and infrastructure projects.

SOURCE:

https://www.thehindu.com/opinion/op-ed/the-severe-erosion-of-fiscal-federalism/article67818283.ece

THE CONTEXT: Ever since the start of the Fourteenth Finance Commission award period (2015-16), the Union government has been reducing financial transfers to States. This is in contrast given that the Fourteenth Finance Commission recommended devolving 42% of Union tax revenues to States, which is a clean 10 percentage points increase over the 13th Finance Commission’s recommendation. The Fifteenth Finance Commission retained this recommendation of 41%, excluding the devolution to Jammu and Kashmir (J&K) and Ladakh, which were recategorised as Union Territories.

ISSUES

• Weakening of cooperative federalism: The Union government’s moves are reducing the aggregate financial transfers to States. The Union government has not only reduced the financial transfers to States but also increased its own total revenue to increase its discretionary expenditure. The discretionary expenditures of the Union government are not being routed through the States’ Budgets, and, therefore, can impact different States in different ways.
• Lesser share for states in gross tax revenue: The Finance Commissions recommend the States share in the net tax revenue of the Union government. Though the Fourteenth and Fifteenth Finance Commissions recommended 42% and 41%, respectively, of the net tax revenue to be the shares of States, the share of the gross tax revenue was just 35% in 2015-16 and 30% in 2023-24. While the gross tax revenue of the Union government increased from ₹14.6 lakh crore in 2015-16 to ₹33.6 lakh crore in 2023-24, the States’ share in the Union tax revenue increased from ₹5.1 lakh crore to ₹10.2 lakh crore between these two years. In other words, the gross tax revenue of the Union government more than doubled while the share of States just doubled.
• Decline in Grants in aid: Grants-in-aid to States is another statutory grant recommended by the Finance Commission. The grants-in-aid to States declined in absolute amount from ₹1.95 lakh crore in 2015-16 to ₹1.65 lakh crore in 2023-24. Thus, the combined share of the statutory financial transfers in the gross tax revenue of the Union government declined from 48.2% to 35.32%.
• Increasing cess and surcharge: The Union government is increasing tax collection under cess and surcharge categories mainly to implement its own schemes in specific sectors, and at the same time, the revenues so raised need not be shared with the States.
• More centralisation of public expenditure: When the financial transfers to States either as tax devolution or grants-in-aid decline this leads to availability of larger discretionary funds for the Union government to spend. This could affect the equity in distribution of financial resources among States.
• Increase in allocation for CSS: The Union government has two other routes of direct financial transfers to States, i.e., Centrally Sponsored Schemes (CSS) and Central Sector Schemes (CSec Schemes). Between 2015-16 and 2023-24, the allocation for CSS increased from ₹2.04 lakh crore to ₹4.76 lakh crore through 59 CSS. Thus, the Union government compels the State to spend more.
• Inter state inequality: This creates two different effects in terms of inter-State equity in public finances. Wealthy States can afford to commit equivalent finances and leverage Union finances inwards through the implementation of CSS. Less wealthy States will have to commit their borrowed finances in these CSS, thus increasing their own liabilities. These differential trajectories of the public finances of States accentuate inter-State inequality in public finances, the major reason being CSS.
• Scope for anti-federal fiscal policies: Together with statutory grants, the total financial transfers as a proportion to gross tax revenue were only 47.9% in 2023-24. Further, the non-statutory grants are tied grants, i.e., they have to be spent on specific schemes for which the grants are allocated. This reduces the freedom of States in conducting public expenditure.
• More power to Union government: In addition to retaining more than 50% of gross tax revenue, the Union government incurs a fiscal deficit to the extent of 5.9% of Thus, the Union government wields enormous financial powers with limited expenditure responsibilities.

THE WAY FORWARD:

• Increase the devolution: There is a need to increase the devolution of states to bring the cess and surcharges collections under a divisible pool, given that these are legitimate revenues and states do not have these additional leverages. By this inclusion, States will get a bigger pie of devolution from the Centre’s net proceeds to meet their expenditure commitments.
• Consensus Building: There is a need for collaboration and consensus building between the Centre and States for open discussions on fiscal matters. Finance commission can act as a mediator and facilitator in fostering dialogue.
• More weightage to fiscal efficiency: The Finance commission can give more weightage to fiscal efficiency in its criteria for transfers. By emphasizing fiscal consolidation and measuring the tax effort of States, the FC can encourage responsible financial management.
• Addressing Fiscal Disparities: There is a need to address the disparities between states by providing financial transfers to less economically developed states. Revenue deficit grants and other means can help bridge the fiscal gap and supports states with limited revenue-raising capacity.
• Promoting Cooperative Federalism: There is a need for an institutional mechanism that fosters cooperative federalism by facilitating intergovernmental fiscal transfers. It encourages collaboration and coordination between the Centre and the States, fostering a sense of shared responsibility in fiscal matters.
• Strengthening Fiscal Discipline: There is a need to promote fiscal discipline and accountability of states as well. It can be done by assessing the fiscal performance and needs of the States, to encourage responsible fiscal behaviour and to discourages unnecessary spending practices.

THE CONCLUSION:

There is constant fall of finances allocated to state from the Union government which is harming not only federalism in the country but hitting fiscal health of the nation. There is a need for constant review of the financial health of States and make periodic recommendations based on the evolving economic scenario.

UPSC PREVIOUS YEAR QUESTION

Q. How have the recommendations of the 14th France Commission of India enabled the States to improve their fiscal position? (2021)

MAINS PRACTICE QUESTION

Q. The Centre’s tax devolution to the States, which has been consistently falling short of the Finance Commission’s recommendation is a bad sign for cooperative federalism. Comment.

SOURCE: https://www.thehindu.com/opinion/lead/the-unions-reins-on-financial-transfers-to-states/article67818520.ece