States and the challenge before the Finance Commission
Source: The Hindu
For Prelims:
Sixteenth Finance Commission Background: The Sixteenth Finance Commission, chaired by Arvind Panagariya, was convened in Tamil Nadu to address fiscal challenges and recalibrate the fiscal relationship between the States and the Union. It has been tasked with outlining fiscal policy and financial distribution for the next five years, taking into account global economic shifts and internal resource allocations.
Key Provisions:
- Objectives: Ensure equitable distribution of financial resources while incentivizing growth, particularly in progressive states like Tamil Nadu.
- Global Economic Trends: Take into account reshoring and friendshoring, influencing trade and investment, and leverage this shift to benefit India’s economy.
- Challenges in Devolution: Address past gaps where devolution fell short of the expected 41% share, primarily due to cess and surcharges by the Union.
For Mains:
GS II: Governance – Fiscal Federalism and State Autonomy
Highlights of the Article
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Fiscal Balance Between States and Union
- The Commission’s decisions will play a pivotal role in defining the fiscal future of India.
- Historically, Finance Commissions have aimed for equitable redistribution, yet discrepancies remain, such as the Fifteenth Finance Commission’s reduced devolution share of 33.16% compared to the expected 41%.
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Challenges for Progressive States
- Tamil Nadu’s Unique Demographic Challenges: With an aging population, Tamil Nadu faces decreased consumption-based tax revenue and increased support costs, which can hinder economic progress and risk the “middle-income trap”.
- Urbanization: The state is projected to have a 57.3% urban population by 2031, posing challenges in infrastructure funding and sustainable growth.
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Policy Directions and Proposals
- Increasing Devolution: A fair share should be raised to 50% of gross central taxes to ensure states have greater fiscal autonomy.
- Growth Incentives: Focusing on equitable distribution that encourages growth for high-performing states while aiding less-developed ones.
- Sustainability and Infrastructure: Addressing the needs of urbanization through targeted resource allocation.
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Strategic Considerations
- Resource Allocation Approach: Striking a balance between a larger national economic pie and equitable shares, ensuring growth for all states.
Beyond Fiscal Arithmetic: The Commission’s mandate extends to fostering manufacturing, addressing urban challenges, and promoting climate resilience.
UPSC EXAM NOTES ANALYSIS
1. Opportunities and Global Changes
- The decisions made by this Finance Commission are set to not only determine the fiscal landscape of the country for the next five years but also shape India’s long-term economic trajectory.
- The Sixteenth Finance Commission’s efforts come at a time of major shifts in global economic trends, including concepts like “friendshoring” and “reshoring,” which are transforming international trade and investment dynamics.
- These changes provide a unique opportunity for both India and Tamil Nadu. The key challenge for the Finance Commission is to balance fair resource redistribution while also promoting growth in economically successful states like Tamil Nadu.
- Since the establishment of the first Finance Commission in 1951, each subsequent Commission has taken a unique approach to tackle the fiscal issues of its era. They have aimed to redistribute resources equitably, enhancing the share of states through vertical devolution and directing funds to less-developed states via horizontal devolution.
- However, there have been significant discrepancies between the objectives set by these Commissions and their actual outcomes, highlighting the need for a more just system for resource distribution.
- For example, although the Fifteenth Finance Commission allocated 41% of the divisible pool to states, the actual devolution during the first four years was only 33.16% of the Union’s gross tax revenue. This shortfall can be attributed to the Union’s unprecedented use of cess and surcharges, which led to a reduced share for states
2. State's Share and incentives
- States, being closer to the public, take on significant developmental responsibilities, so their share of resources should be increased substantially. States have faced considerable financial pressure due to the rising costs of counterpart funding for centrally sponsored programs combined with insufficient devolution.
- Therefore, a fair and just allocation would involve devolving 50% of the gross central taxes to states, granting them more fiscal autonomy to fund and execute projects tailored to their needs.
- Regarding horizontal devolution, it is apparent that the redistribution policies in place during the first 45 years have not effectively fostered real growth.
- This brings up a critical question: should the focus be on a smaller national economic pool with larger shares for less-developed states, or a larger economic pool with equitable distribution that benefits everyone?
- While the answer is complex, a more balanced approach would support a growing national economy, ensuring adequate resources for both less-developed and progressive states. Such a strategy would require an allocation system that rewards high-performing states, enabling them to reach their full potential and drive national economic growth
3. Challenges
- It is also crucial to recognize that progressive states like Tamil Nadu face distinct demographic and urbanization challenges. With a median age above the national average, the state’s ability to generate tax revenue from consumption is diminishing, while the expenses associated with supporting an aging population are increasing.
- It is essential to prevent such states from falling into the “middle-income trap,” where growth stalls, leading to a situation where they “grow old before becoming rich.”
- Additionally, the challenges brought by rapid urbanization in these states need proper attention. For instance, Tamil Nadu is experiencing the highest rate of urbanization in the country, and by 2031, its urban population is projected to reach 57.30%, far surpassing the expected national average of 37.90%. Resources must be allocated to meet the infrastructure needs arising from urban growth, ensuring long-term sustainable development.
- The Commission’s role extends beyond mere fiscal calculations; it must envision a future in which each state plays a part in and benefits from national progress.
- Whether promoting manufacturing, tackling urbanization challenges, or fostering climate resilience, the Commission’s decisions will affect millions and shape the path for India to emerge as a leading global economy
4. Conclusion
Sixteenth Finance Commission holds a critical responsibility in addressing India’s evolving fiscal landscape and ensuring that resource allocation is fair and growth-oriented. While achieving equitable distribution among states remains a priority, it is equally essential to incentivize high-performing states like Tamil Nadu, enabling them to sustain their growth and contribute to the nation’s economic progress. The Commission must balance the need for targeted support for less-developed regions with strategies that empower progressive states to continue driving development and avoid the middle-income trap. Additionally, the unique challenges posed by demographic shifts and rapid urbanization in such states must be addressed to ensure long-term sustainability and resilience. Ultimately, the Commission’s decisions will play a pivotal role in shaping the future trajectory of India, fostering inclusive growth, and positioning the country as a formidable player in the global economy
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Mains Practice Questions
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