There is a notion that the Union government shares its tax revenue with the states as an act of benevolence. However, the constitutional provision for a Finance Commission amply clarifies that every state has a legitimate claim to the Union tax revenue. The framers of our Constitution expected the commission’s neutrality as an adjudicator to distribute the revenue.
Understandably, even if an adjudicator is technically fair, any hint of partiality undermines the legitimacy of its decisions in the eyes of the claimants. The 16th Finance Commission (16FC) faces this doubt on two counts. First, for its tweaking of the horizontal devolution formula to convert the efficiency criteria. And second, the interesting deviation from its predecessors in not providing an annexure detailing the calculations for each criterion. The state-wise data used for the calculations was uploaded to the Finance Commission website days after the report was presented to Parliament.
Though the 16FC retained 41 percent as the states’ share, seemingly minor tweaks in the horizontal devolution formula created massive changes in the states’ relative shares. Of the six criteria used by the 15FC, three (2011 population, area, and per-capita state GDP distance) were retained with only minor adjustments to the weights; the remaining three (forest, demographic performance and tax effort) were modified.
Here, we discuss two hugely consequential modified criteria. Demographic performance was measured by the 15FC by the impact of states’ total fertility rates (TFRs) on their 1971 populations, whereas 16FC measures the impact of population growth rate (1971-2011) on the 2011 population. And the tax effort in 15FC is replaced in 16FC by the square-root of states’ contribution shares to GDP as an efficiency criterion.
The reason for dropping TFR is that it leads to an increase in the ageing population, which the 16FC thinks should be discouraged. This argument is very much contestable, as many academic studies show that a TFR decrease is not the sole reason for a population ageing.
But the curious twist lies in how the replaced variable is used. The 15FC took the inverse of this TFR and multiplied it by the 1971 population, while the 16FC did the same with the inverse of population growth, multiplied by the 2011 population—thereby completely discarding the 1971 population. In doing so, the 16FC effectively combined the 10 percent weight of demographic performance with 17.5 percent of the population criterion. The states that controlled population gained only 1 percent of the devolution share, compared to the situation in which the population criterion had 27.5 percent weight and demographic performance 0 percent.
But the real issue is in the mathematical properties of an inverse function. In such a function, there exists a nonlinearity in the rate of change when the values of the denominator are greater or less than those of the numerator. The TFR calculated by the 15FC is greater than 1 for all states; its inverse, 1/TFR, places all states on the same side of the line. The 16FC’s formula, where the numerator is greater for the states that controlled population, results in injustice to performing states. the shift in the base year for population from 1971 to 2011 amplifies the degree of differential treatment.
A similar mathematical property of a square-root function is again used to avoid giving the performing states their legitimate share under the contribution to GDP criterion.
On the case of the missing annexure, the previous two FCs had provided these tables with precise decimal points, making the calculations transparent and verifiable. Even a slight difference can shift the share’s decimal point, and this shift can yield a significant monetary gain or loss for the states. The critical issue is particularly with reference to the estimates of GSDP and population projections to derive per-capita GSDP numbers, as two criteria with a combined weight of 52.5 percent are using these estimates to derive states’ shares.
The 16FC reports that it used RBI data on state finances and demographic projections from the health and family welfare ministry, which provides population projections till 2036. But their website mentions that the GSDP and population data are sourced from the ministry of statistics and programme implementation (MoSPI). The state-wise GDP reported in the 16FC data file differs from the one available on the MoSPI website. The same is true for the population projections available from the Report of the Technical Group of Population Projections published by the health ministry and MoSPI.
Given these variations from reliable government sources, there must be a convincing explanation for using that particular data. Even a slight variation is reflected in the calculated share, and every decimal is real money for the states and their people.
Thus, the 16FC’s horizontal devolution formula raises legitimate concerns, not mere inconsequential technical objections. It systematically dampens rewards for better performing states. In addition, the data discrepancies erode the very trust that a constitutional body of this stature must command. The Finance Commission mandate is not merely a technical exercise in arithmetic; it is an act of federal justice. When the mechanics of that justice are opaque, the legitimacy of the entire exercise comes into question.
S Raja Sethu Durai
Professor of economics, University of Hyderabad
R Srinivasan
Former Professor, University of Madras
(Views are personal)