The Finance Commission is a constitutional body instituted by the Union government once in five years without any transparent discussion on selecting its members and its terms of reference (ToR). The FC’s recommendations are not justiciable and not all recommendations are accepted by the government. Hence, apprehension about its neutral role in the distribution of tax revenues between the Union and state governments and grants-in-aid is not unfounded.
Normally, the Union government adds to the constitutionally mandated ToR using the Constitution’s Article 280, sub-clause 3(d)—“any other matter referred to the commission by the president in the interests of sound finance”. The NDA government gave a long ToR for the 15th FC that was coercive in more than one way. But the ToR for the 16th FC is just a reproduction of relevant provisions in Article 280. The change of mind was surprising.
It would not be a surprise if the new coalition government gives additional ToRs to the 16th FC. New Delhi is known for opacity in governance. The coalition partners from the states should act to bring in a federal spirit in the FC’s functions.
Evolving terms of reference
If we peruse additional ToRs to various FCs, we get an idea about the development of fiscal policies and how the Centre coerced states to follow what it believed as fiscal prudence. The ToR of every FC retained almost all items in the previous ToR. This led to increasing ToRs for successive FCs.
A few ToRs added down the years are given here. One, for maintenance expenditure of the assets created by plan schemes, debt servicing expenditures shall be considered (4th FC). Two, while deciding the states’ share in tax revenue, the revenue and expenditure commitments of the Union government shall be considered (5thFC). Three, the ToR for the 6th FC specified requirements of backward states to improve their administrative efficiency should be considered. Four, the need for ensuring reasonable returns on investments in irrigation and power projects, transport undertakings, industrial and commercial enterprises and the like was stipulated in the ToR for the 7th FC. It also specified to take 1971 population as a factor for determining taxes, duties and grants-in-aid. Five, the language of the ToR for the 9th FC (1987) reflected the economic reform process of the government. Many items from the ToRs of previous FCs were abridged and obvious reform phrases were used. Six, the ToR for the 11th FC included specific references to augmenting states’ finances to devolve funds to local governments as per the 73rd and 74th Amendments of Constitution.
From the 12th FC to the 15th FC, the ToRs prominently contained the references to suggest measures to reduce public debt and restoring balanced Union and state budgets. The ToR for the 14th FC specifically asked the FC to consider the demographic change since 1971. The ToR for the 15th FC explicitly stipulated the use of 2011 census instead of 1971, wherever population was a criterion.
The Union government need not accept all the recommendations of an FC. Almost all the FCs since the 1stFC recommended the creation of a permanent administrative establishment for FC to monitor the implementation of the recommendations and to collect real-time data on finances and other issues, and also an independent public-debt management institution. For more than 75 years, the Union government has not accepted this recommendation.
Almost all the recommendations regarding states’ debt management were accepted in principle and some were implemented. One such was on the state fiscal responsibility laws. The requests to amend the states’ fiscal responsibility laws were not accommodated, but those for the Union government were taken up several times to change the restrictive deficit ratios. The action taken reports on the recommendations of the 14th and 15thFCs show the Union government had implemented the recommendations regarding tax devolution and grants-in-aid; other recommendations were to be implemented after thorough studies. This leaves the scope to change the recommendations according to the Union government’s preferences.
What should states do?
The states should get together to express their concerns about the ToRs for the 16th FC and compel the Union government not to add any other item. There are possibilities for the Union government to influence the FC to take a particular view or take up an issue that is not referred to it.
First, the states should ask the FC to institute a transparent process of decision-making, such as publishing a draft paper on the issues in the ToR. Second, the normative approach to the revenue and expenditure projections of states should be discussed in a democratic manner. Third, a specific path to debt sustainability should be recommended in view of their different fiscal situations. Fourth, the issues to decide on the vertical share of the Union government’s tax revenue should be discussed, with the states and the Union government as equal partners in generating and sharing tax revenues. Fifth, the horizontal sharing formula for distributing state share should be discussed because the 2021 census has not yet been conducted. It is equally important to resolve the long-pending issue of a trade-off between equity and efficiency in the distribution formula. There is a lot the states have to deliberate with the new government in New Delhi.
(Views are personal)
R Srinivasan | Member, Tamil Nadu State Planning Commission
J Jeyaranjan | Vice Chairman, Tamil Nadu State Planning Commission