Central transfers and the issue of shares of some states
The Finance Commission of India is a constitutional body established under Article 280 of the Indian Constitution. Its primary function is to define the financial relations between the Union Government and the State Governments.
Functions
- Recommend the distribution of the net proceeds of taxes between the Union and the States.
- Recommend the principles governing grants-in-aid to the States out of the Consolidated Fund of India.
- Review the existing system of revenue collection and suggest measures for improving it.
- Examine the financial position of the Union and the States and suggest measures to improve their fiscal health.
Composition
- The Commission is chaired by a Chairperson, who is usually a retired judge or eminent economist.
- Other members include representatives from the Union Government and the State Governments.
- The Commission is constituted every five years.
Recent Developments
- The 15th Finance Commission submitted its report in 2020, recommending a 41% share in the net tax revenue for the States (excluding J&K and Ladakh).
- The 16th Finance Commission is currently in operation and is expected to submit its report by October 2025.
Criticisms and Challenges
- Some critics argue that the Commission's recommendations favour the Union Government over the States.
- Others point to the complex and opaque nature of its calculations.
- There have also been concerns about the timeliness and implementation of its recommendations.
Cooperative federalism in India refers to the collaborative relationship between the central government and the state governments, aimed at achieving shared goals, promoting inclusive development, and ensuring effective governance across the country. It emphasizes partnership, coordination, and mutual respect between different tiers of government.
Constitutional Framework
India follows a federal system of governance, where powers and responsibilities are divided between the central and state governments as outlined in the Constitution. The Seventh Schedule of the Constitution delineates the powers of the Union and State governments, ensuring a clear demarcation of authority while also allowing for cooperation and coordination.
Principles of Cooperative Federalism
- Mutual Respect and Recognition: Cooperative federalism emphasizes the recognition of each level of government's autonomy and authority, respecting their jurisdiction and decision-making powers.
- Shared Responsibility: It underscores the idea of shared responsibility in addressing national challenges and achieving common objectives, with both the central and state governments contributing to policy formulation and implementation.
- Consultative Process: Cooperative federalism involves a consultative and participatory approach, where decisions are made through dialogue, consensus-building, and collaboration among all stakeholders.
- Decentralization of Power: It advocates for decentralization and devolution of powers to the grassroots level, empowering local governments and communities to participate in decision-making and governance processes.
- Fiscal Federalism: Cooperative federalism also encompasses fiscal federalism, ensuring equitable distribution of financial resources, tax revenues, and grants-in-aid among different tiers of government.
Key Initiatives and Mechanisms
- Inter-State Council: Established under Article 263 of the Constitution, the Inter-State Council serves as a platform for fostering cooperation and coordination among states and between the central and state governments on issues of common interest.
- Goods and Services Tax (GST): The introduction of GST exemplifies cooperative federalism by creating a unified tax regime across the country, with both the central and state governments jointly administering and sharing revenues.
- National Institution for Transforming India (NITI Aayog): NITI Aayog acts as a platform for cooperative federalism by facilitating dialogue, policy coordination, and collaboration between the central government, state governments, and other stakeholders.
- Schemes and Programs: Several schemes and programs launched by the central government involve active participation and cooperation from state governments, such as the Swachh Bharat Mission, Ayushman Bharat, and Smart Cities Mission.
Challenges
Despite significant progress, challenges remain in realizing the full potential of cooperative federalism in India. These include issues related to inter-state disparities, administrative capacity, and political will. Strengthening cooperative federalism requires continuous dialogue, institutional reforms, capacity-building measures, and a shared commitment to inclusive and sustainable development.
3. Impact of Distance Criterion on Tax Devolution and State Shares
The distance criterion plays a crucial role in determining the shares of individual states in tax devolution, as highlighted by various Finance Commissions from the Twelfth to the Fifteenth. This criterion, which assigns weights to different parameters, has witnessed adjustments over time, impacting the fiscal allocations to states significantly.
- Weight Adjustments by Finance Commissions: The weight assigned to the distance criterion has evolved across Finance Commissions. Starting from a weight of 62.5% in the Eleventh Finance Commission, it was reduced to 47.5% by the Thirteenth Finance Commission and further decreased to 45% by the Fifteenth Finance Commission. This reduction reflects a shift in emphasis on other criteria over time.
- Impact on State Shares: The distance criterion operates based on the principle that states farther from the highest-income state receive a higher share. Consequently, southern states have experienced a loss in their share due to this criterion. For instance, between specific Finance Commissions, the southern states collectively saw a reduction of 8.055% points in their share because of the distance criterion.
- Contrasting Effects on States: While low-income states like Bihar and Uttar Pradesh have gained from the distance criterion, they have experienced losses under other criteria, leading to an overall decline in their share. For example, despite gaining from the distance criterion, these states witnessed an overall loss of 0.970% points and 1.325% points, respectively, in their share.
- Equalisation Principle and Social Justice: The equalisation principle, a fundamental tenet in India and globally, guides the distribution of resources. It ensures that states with varying economic capacities receive equitable support, aligning with principles of economic and social justice.
- Consideration of Multiple Criteria: It's crucial to recognize that tax devolution and state shares are influenced by a combination of criteria, including but not limited to the distance criterion. Factors such as the area/forest criterion, among others, also play a role, particularly benefiting hilly states.
4. Impact of Population Criterion and Demographic Change on Fiscal Allocations
The population criterion has been a topic of contention, especially concerning the data used and its implications for fiscal allocations. Historically, data from different census years have been utilized, leading to adjustments in subsequent Finance Commissions to address evolving demographic trends.
- Transition in Population Data: Until the Fourteenth Finance Commission, population data from the 1971 census was employed for fiscal calculations. However, with the Fifteenth Finance Commission, there was a shift to using population data from the 2011 census. This transition aimed to align fiscal allocations with updated demographic realities.
- Introduction of Demographic Change Criterion: To avoid penalizing states that demonstrated progress in reducing fertility rates and managing population growth, the demographic change criterion was introduced. This criterion acknowledges states' efforts in curbing population growth, thereby mitigating potential adverse effects on fiscal allocations.
- Joint Impact on States: The combined impact of transitioning to 2011 population data and introducing the demographic change criterion has had a marginal effect on states across different groups. While this change has not significantly altered fiscal allocations, it reflects a nuanced approach to considering demographic shifts and states' efforts in population management.
- Example of Tamil Nadu: For states like Tamil Nadu, the joint impact of these changes has been marginally positive. This suggests that the state's performance in managing population dynamics and demographic changes has been acknowledged, reflecting a fairer approach to fiscal distribution.
- Balancing Data Accuracy and Incentivizing Progress: The evolution in population criteria underscores the ongoing efforts to balance data accuracy with incentivizing states for progress in critical areas like fertility rates and demographic stability. By incorporating such nuanced criteria, fiscal allocation mechanisms strive to promote equitable and sustainable development across states while considering their demographic realities.
5. Recommendations for Fiscal Reforms
Addressing Concerns on Income Distance Criterion
The income distance criterion, despite its significance, has raised questions about its long-term sustainability. While it remains a crucial factor in fiscal allocations, there are steps that the Sixteenth Finance Commission can consider to address related concerns.
- Gradual Reduction in Weight: The Sixteenth Finance Commission could contemplate gradually reducing the weight of the income distance criterion. A reduction of 5% to 10% points can help mitigate the impact on states experiencing declining shares while maintaining fairness in distribution.
- Balancing Criteria Weights: To compensate for the reduced weight of the income distance criterion, the Commission can correspondingly increase the weights attached to other criteria. This balanced approach ensures that multiple factors influencing fiscal allocations are appropriately considered.
Enhancing Divisible Pool Size and Share of States
The size of the divisible pool and the share of states in revenue receipts are crucial aspects that influence fiscal transfers and state finances. Certain measures can be explored to enhance these aspects.
- Limitation on Cesses and Surcharges: The Centre's decision to raise cesses and surcharges post the Fourteenth Finance Commission's recommendation of a higher state share has reduced the size of the divisible pool. The Sixteenth Finance Commission can consider imposing a limit, such as capping cesses and surcharges at 10% of the Centre's gross tax revenues. This would help maintain the size of the divisible pool and uphold the intended increase in state shares.
- Revisiting Revenue Sharing: Given the fluctuations in state shares over recent years, there is a need to revisit revenue-sharing mechanisms to sustain the increased share of states in revenue receipts. This reassessment should aim to stabilize and potentially enhance the state's share to ensure continued fiscal stability and growth.
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Mains Pratice Questions
1. Analyze the impact of the distance criterion on tax devolution and state shares as highlighted by various Finance Commissions. How has the weight of this criterion evolved, and what are its contrasting effects on different states? (250 Words)
2. What are the criticisms and challenges faced by the Finance Commission in its functioning? How can transparency and timeliness be improved in its recommendations and implementations? (250 Words)
3. Evaluate the transition in population data and the introduction of the demographic change criterion in fiscal allocations. How have these changes affected states' shares, particularly considering states like Tamil Nadu? (250 Words)
4. What are the key considerations for the Sixteenth Finance Commission in making recommendations for fiscal reforms in India? How can these reforms contribute to achieving balanced economic growth and addressing regional disparities? (250 words)
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