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

TAG: GS 3: ECONOMIC DEVELOPMENT

THE CONTEXT: The government is likely to ask the next Finance Commission to consider a higher weight for the human development index (HDI) and sustainable development goals (SDGs) while recommending the distribution of resources among states.

EXPLANATION

• The government is currently finalizing the terms of reference for the 16th Finance Commission, which is likely to be set up shortly.
• According to the senior official, the commission may also be asked to look at the conditions attached to fiscal transfers to urban and rural local bodies, to ensure that the funds are effectively utilised.
• The 15th Finance Commission gave 12.5% weight to demographic performance, 45% to income, 15% each to population and area, 10% to forest and ecology, and 2.5% to tax and fiscal efforts.

ABOUT FINANCE COMMISSION

• The Finance Commission is a constitutional body that determines the method and formula for distributing tax proceeds among the Centre and states.
• It suggests distribution of taxes and grants and works based on the terms of reference set by the finance ministry for a five-year period.
• The recommendation of the 16th Finance Commission will be applicable for the period from April 2026 to March 2031.
• Ritwik Pandey, a 1998 batch IAS officer of the Karnataka cadre, appointed as an officer on special duty at the advance cell of the Finance Commission.

TERMS OF REFERENCE FOR THE 16^th FINANCE COMMISSION

According to the official, the terms of reference could include consideration of climate issues while deciding distribution of funds among states keeping in view India’s commitment to climate financing and to prepare states and cities to tackle future adverse weather conditions and natural disasters.

THE 15^th FINANCE COMMISSION

• The 15th Finance Commission had allocated ₹54,770 crore under the National Disaster Relief Fund and ₹1.28 lakh crore for state disaster relief funds.
• The Centre’s share in state disaster relief funds was ₹98,080 crore.
• Improving the financial health of municipal bodies is part of the government’s pending agenda.

INEFFICIENT FUND UTILISATION

• The Reserve Bank of India, the Department of Expenditure and state finance commissions have repeatedly flagged inefficient fund utilization as well as poor accounts and record keeping by some municipal bodies.
• According to the official, the commission could be asked to look at conditions-based transfer to make fund utilization by local bodies effective and transparent.
• The total central grant to local governments is estimated to be ₹4.36 lakh crore for the 15th Finance Commission period (FY22-FY26), of which ₹2.36 lakh crore is earmarked for rural local bodies and ₹1.21 lakh crore for urban local bodies.
  • Another ₹70,051 crore is for health grants through local governments.

HUMAN DEVELOPMENT INDEX(HDI)

• The Human Development Index (HDI) is a statistical tool used to measure a country’s overall achievement in its social and economic dimensions.
• Every year United Nations Development Programme (UNDP) ranks countries based on the HDI report released in their annual report.
• HDI is one of the best tools to keep track of the level of development of a country.

SUSTAINABLE DEVELOPMENT GOALS(SDGs)

• The Sustainable Development Goals (SDGs), also known as the Global Goals, were adopted by the United Nations in 2015 as a universal call to action to end poverty, protect the planet, and ensure that by 2030 all people enjoy peace and prosperity.
• The 17 SDGs are integrated.
  • They recognize that action in one area will affect outcomes in others, and that development must balance social, economic and environmental sustainability.

Source: finance commission: New Finance Commission may tweak formula; SDGs, climate could get more weight – The Economic Times (indiatimes.com)