There were great expectations from the 14th Finance Commission to transform the fiscal ecology of the country given that a new government had been elected and it was talking of transforming governance under the slogan of “minimum government maximum governance” and strengthening transparency and accountability. Further the implementation of the 14th FC coincides with the 2015-16 budget which is the first full budget of the new regime in power at the Centre. The Finance Minister in his budget speech said that this budget will make India fly, with acceleration of economic growth to 7.4% the fastest in the World, and set in process an unprecedented transformation of India’s economic and social development.
The big news emanating from the 14th FC is the 10 percent point increase from 32% to 42% share of states in the divisible pool of taxes. There is euphoria all around that states will get a much larger share from the tax kitty. What does this really mean? Yes the states are getting a much larger share of taxes as unconditional transfers, to be precise 31.25% more as a share compared to the 13th FC period, which means that they have more funds to plan their development strategies autonomous of the Centre, meaning delinked from Centre’s planned programs and schemes. So the positive aspect is that the fiscal space of the states to do their own thing has expanded substantially.
But has the total fiscal envelope of the states really expanded as much? The answer is no. While the proportion of unconditional transfers have increased substantially the total transfers have not increased as much – just about 2 or 3 percent points. The “magic” that has happened is that with the “shut-down” of the Planning Commission a large part of the funds that the Centre transferred through various plan schemes have now been assigned directly to the states. Thus we see that there is a huge jump of 37% from the previous year in tax transfer (unconditional revenues) to states in 2015-16 budget in accordance with the 14th FC mandate but on the other hand for grants and loans from Centre to states we see a huge decline of 19% for the same period, mostly in the financing related to Central Assistance for State plans. In 2014-15 the total transfer of resources from the Centre to states was 51% and this has increased to 53% in 2015-16, a gain of mere 2 percent in the overall fiscal envelope which amounts to just 0.58% of GDP. Infact the 2014-15 budget had already begun that process of shifting many of the plan schemes into the state pool. In contrast the fiscal space of the Centre has shrunk consequently and this would impact budgets of a number of its line departments, especially social sector and anti-poverty programs. The big challenge emerging from this is would the states use their larger fiscal space to fill the gap that would be created with compression in the allocations of Centre’s line departments?
So given this reality the euphoria is unwarranted. The states have serious thinking and strategizing to do if they have to take advantage of this new opportunity and trajectory. At one level they have a larger fiscal space but at another level their challenge is to use this additional fiscal space effectively to fill the gaps and deficits in development and service delivery in their states. Thus defining appropriate priorities as per the needs and demands of their citizens becomes critical to achieving their development goals. This also opens up the space for civil society groups to engage with the states in determining these priorities.
At the level of the Centre their fiscal space may appear to be reduced but with the Planning Commission fading out they have simply slashed a whole lot of plan schemes which the Centre used to give as grants to the states from its own resources as assistance for state plans. But as mentioned above the loss in the Centre’s total fiscal envelope is only 0.58% of GDP but against this small deficit the burden on the states in terms of responsibility to continue and strengthen various ongoing programs that the Centre has now seconded to the states is perhaps much larger.
Further the 14th FC has also done away with sector specific grants that earlier FCs had included arguing that such priorities are best decided by the states and often such specific grants were an imposition from above and many states did not like it. Hence this became the logic for raising the unconditional ratio from the divisible tax pool so that states had a greater autonomy or freedom to plan as per its own needs and priorities. The 14th FC in the light of this recommendation has suggested a new institutional mechanism through which the Centre can engage with states in a transparent manner to facilitate additional resource transfers from the Centre’s fiscal envelope now that the Planning Commission has ceased to exist.
The 14th FC has also continued with making provisions for local governments, both panchayat and municipal bodies. It is at this local level where transparency and accountability is the weakest and hence the grant has been bifurcated into two parts, one as their dedicated share for basic services (90% for panchayats and 80% for municipalities) and the other part (10 and 20 percent respectively) based on performance wherein two critical transparency indicators have been indicated – timely publication of accounts and publishing service delivery benchmarks and also efforts at raising their own revenues (see box below). Further the state is being held to account to disburse grants to the local bodies within 15 days of receiving the grant from the Centre and the latter has also been mandated to release the grant in 2 instalments, one in June and the other in October.
The above again is a great opportunity for civil society groups, who work mostly at the local level to use this FC recommendation to strengthen access to budget information at the local level as well as use this information to make service delivery accountable to citizens.
Finally the 14th FC has also recognised that a substantial increase is needed in the tax:gdp ratio but it has been able to project an increase of only about 2% additional (0.67 at the Centre level) by the end of the 14th FC period. This would continue to remain a major constraint for increasing the share of social sectors in the budget and hence would require concerted efforts by civil society groups to engage the Finance Ministry on taxation and tax expenditure issues wherein with elimination of upto two-thirds of tax expenditures and stronger tax compliance nearly 5% of the GDP can be reined in taking the tax:gdp ratio at the national level to 21% from the present 17%. However the 2015-16 budget has taken a regressive step on taxes by reducing corporate tax rates from the present 30% to 25%, a decline of nearly 17%. This along with the 2% increase in service tax rates and removal of the wealth tax has pushed back the little progressive growth we had seen in taxation policy in the last few years. And ironically the budget estimates for tax revenues of the Centre in absolute numbers show a decline of Rs. 57000 crores from the previous year or 0.4% of GDP. This is some kind of history that this years budget has achieved.