Finance commission recommendations are, technically, a zero-sum game, where a tweak in the criteria cannot be carried out to benefit all the states—a gain for some states is a loss for others. So, finance commissions always have a very tight rope to walk.
Until the 7th Finance Commission (FC), only two criteria for devolution were used—population and state contribution towards income tax collection, with 80-90 percent, and 10-20 percent weights, respectively. The 8th FC breaks this tradition and introduces multiple equity criteria, with per capita income distance getting more weight, and remaining a dominant criterion for the past eight commissions. Population and income distance constitute nearly 70 percent of the weights, and most of the remaining 30 percent is distributed across fixed geographic criteria like area and forest cover, with little weight assigned to efficiency.
We must wait to see whether the 16th FC paves a new direction by drastically changing the criteria by giving more weight to efficiency parameters, or follows the same path as their predecessors by slightly modifying the weightage, or reintroduces some of the past criteria so that there is no drastic change in inter se shares.
With a maximum weight, the income distance criterion becomes the most contentious one for the progressive states with higher per-capita incomes, as they get a lesser share in the devolution. With no incentive for performance, the states with low per-capita income lack the urge to move up the ladder. The basic idea was to make the playing field more level by compensating poorer states to move up in ranks; but the data suggests otherwise. Over the past four decades, there has been no change in the ranks of the states.
Successive FCs calculated the income distance by considering the latest available three-year data on each state’s per capita gross state domestic product (GSDP), and an average is calculated to smoothen the variation. The income distance for a particular state is the difference between its per-capita GSDP from the highest per-capita GSDP state. If the state with the highest average is a small one, the next comparable state’s average is considered. This distance, multiplied by the state’s population, was used to calculate the share.
Since the states’ ranks on this average remains the same, this method is skewed towards favouring those at the bottom with a higher share and limiting the share for those at the top.
A simple readjustment to this criterion can benefit states fairly and push them to improve their per-capita GSDPs. Consider the per-capita GSDP for all states reported by the last FC, and similarly, calculate the average per-capita GSDP for all states for the latest three-year period. The growth rate between these two averages is the minimum expected growth of the average per-capita GSDP.
We can derive the expected per capita GSDP for each state from this growth rate, and the income distance for each state is calculated as the difference between this expected per capita GSDP, and the highest expected per capita GSDP of a comparable state. This distance multiplied by the state’s population can be used to derive the share for each state. The computed expected level for each state should be kept as the base for calculating the income distance by the successive FCs.
To explain this, let’s take the average per-capita GSDP of the states considered by the 14th and 15th FCs. The average has grown by 94.8 percent, from `64,290 to `1,25,246, between the two commissions. So, by benchmarking the minimum expected growth at this level for all states, the expected average percapita GSDP level can be derived.
Since the compensation to bridge this income distance has been given by the 14FC, it is anticipated that the states will grow at the expected level for the 15FC period. So, calculating income distance with actual data will always favour the states that are not coping well with growth.
Deriving income distance based on this expected level solves two problems. First, it does not punish the states that grow above the expected level; instead, it pushes the states growing below the expected level to pay the price for the gap they miss.
Second, since this expected level would be set as a base to calculate the expected level of average per-capita GSDP of each state in the next commission’s period, it pushes the states that are above the level to maintain the same speed; but pushes those below the level to grow faster than what is needed to maintain the expected level.
With this readjustment, the share of the income distance criterion across states may not change drastically. The difference between the actual and readjusted shares stands at around 5.6 percent for the 15FC period, indicating that only 5.6 percent of the share has been redistributed between the performing and emerging states. But it provides a stable criterion with a predictable target for the states to turn their wheel of performance towards the future.
S Raja Sethu Durai | Professor of economics, University of Hyderabad
(Views are personal)