Charting the path for the Sixteenth Finance Commission

Source:The Hindu

For Prelims: The Finance Commission, Debt-GDP Ratio, Planning Commission,  Goods and Services Tax (GST),  Fiscal Responsibility and Budget Management (FRBM).

For Mains: The Sixteenth Finance Commission (SFC)

Highlights Of the Article:

• The Sixteenth Finance Commission (SFC) should review the vertical dimension of fiscal federalism, i.e., the share of central taxes that should be devolved to the states.
• The SFC should also review the horizontal dimension of fiscal federalism, i.e., the way in which resources are transferred to individual states.
• The current system of tax devolution criteria is too complex and the SFC should focus on equalizing the provision of education and health services across states.
• The FRBM targets are too ambitious and need to be revised.
• The SFC should examine the subject of non-merit subsidies in detail.
• The SFC should be strict about states maintaining fiscal deficit within limits.
• The SFC should set up a loan council to oversee the loan magnitudes and profiles of the central and state governments.
• The SFC should provide carrots to states maintaining fiscal deficit (for example including fiscal performance as a criterion in horizontal distribution) and sticks for those that exceed fiscal deficit limits (by suitably acting on the extent of borrowing allowed).

Context:

The context of the article is the upcoming appointment of the Sixteenth Finance Commission (SFC). The SFC is a constitutional body that is responsible for recommending the sharing of taxes between the central government and the states, as well as the distribution of resources among the states. The FC is appointed every five years.

UPSC EXAM NOTES ANALYSIS:

1.Vertical and horizontal dimensions:

The vertical dimension refers to the share of taxes that is allocated to the States. The horizontal dimension refers to the way in which the share of taxes is allocated to individual States.

The share of States in the divisible pool of central taxes has been increased to 42% from 32%. This is a welcome development, as it will help to reduce the fiscal imbalances between the Centre and the States. However, the share of cesses and surcharges in the divisible pool of central taxes has also increased to 18.5% from 12.8%. This is a matter of concern, as it means that the States are receiving a smaller share of the overall tax revenue.

The Sixteenth Finance Commission should recommend a freeze on the share of cesses and surcharges or an increase in the share of States if the proportion crosses 10%. This would help to ensure that the States receive a fair share of the tax revenue and that the fiscal imbalances between the Centre and the States are reduced.

2.The share of individual States in the Centre's divisible pool of taxes:

The share of individual States in the Centre's divisible pool of taxes is determined by a set of indicators, including population, per capita income, area, and incentive-related factors. The distance criterion, which is based on the per capita income of a State, has the highest weight of 45%. This means that States with lower per capita incomes receive a larger share of the tax revenue.

The Sixteenth Finance Commission should freeze the weight of the distance criterion at the current level or even reduce it to 40%. This would help to ensure that the States with higher per capita incomes receive a larger share of the tax revenue. However, some upward adjustment in the resources transferred to the poorer States may be done through grants.

3.Recommendations:

The debt-GDP ratio for the combined account of central and State governments is still considerably above the FRBM norms. The Sixteenth Finance Commission should re-examine the 2018 amendment to the Centre's FRBM. This amendment has made it more difficult for the Centre and the States to reduce their debt levels.

The Sixteenth Finance Commission should also examine the subject of non-merit subsidies in detail. Non-merit subsidies are subsidies that are not necessary to provide essential goods and services. These subsidies can be a drain on the fiscal resources of the Centre and the States.

The Sixteenth Finance Commission should be strict about States maintaining fiscal deficit within limits. Fiscal deficit is the difference between the government's revenue and expenditure. If the fiscal deficit is too high, it can lead to economic problems such as inflation and currency depreciation.

In conclusion, the Sixteenth Finance Commission has a number of important decisions to make. These decisions will have a significant impact on the fiscal health of the Centre and the States. The Commission should make these decisions carefully and in the best interests of the country.