- Prelims: Current events of national importance(Federalism, Finance Commission, Cess and Surcharges, NITI Ayog, etc)
- Mains GS Paper II & III: Functions and responsibilities of the union and the states, issues and challenges pertaining to the federal structure etc
ARTICLE HIGHLIGHTS
- The government will appoint a Finance Commission to determine how much of the Centre’s tax revenue should be given away to States (the vertical share) and how to distribute that among States (the horizontal sharing formula).
INSIGHTS ON THE ISSUE
Context
Finance Commission:
Background:
- In the pre-reform period: The Finance Commission recommendations were not that critical.
- Because the Centre had other ways to compensate States, or indeed to play favorites, through plan financing and public sector undertaking (PSU) investments.
- Post-reforms, fresh PSU investments have thinned out and the Planning Commission was abolished in 2014.
- The Finance Commission remains virtually the sole architect of India’s fiscal federalism.
- Its responsibility and influence are, therefore, much larger.
Issue about horizontal distribution:
- The Centre gives away 41% of its tax pool to the States:
- States will demand that this proportion be raised.
- But there is not much room for stretching this further given the Centre’s expenditure needs and the constraints on its borrowing limit.
- Previous Finance Commission(appointed in 2017):
- It was asked to take into account the 2011 population figures in determining the expenditure needs of a State.
- This was a departure from the standard practice until then of mandating Finance Commissions to use the 1971 population numbers.
- Not to give a perverse incentive to States to neglect family planning with an eye on a higher share of devolution.
- States which had done well in stabilizing population growth rates(southern States) protested against this change in the base year, calling it a ‘penalty for good performance’.
- Conflict over revenue deficit grants:
- Finance Commission awards to States which remain in deficit on the current account even after tax devolution.
- Revenue deficit grants have a rationale that every State in a country should be able to provide a minimum level of service to its residents even if it involves an element of cross-subsidisation.
- Finance Commissions have struggled to determine how much a State’s deficit is due to its fiscal incapacity and how much is due to fiscal irresponsibility.
- They have tried to tweak the distribution formula to support deficit States without penalizing responsible States.
- Every horizontal distribution formula has been criticized as being inefficient or unfair or both.
- The fault lines across States have deepened in recent years along political, economic and fiscal dimensions.
Issues Finance Commission should focus on:
- Practice by the Centre of increasingly resorting to a levy of cesses and surcharges rather than raising taxes.
- A white paper by the Tamil Nadu government: The proportion of cesses and surcharges in the Centre’s total tax revenue had nearly doubled from 4(ten point four)% in 2011-12 to 20.2(twenty point two)% in 2019-20.
- Centre raises the additional rupee by way of a surcharge, it gets to keep all of it.
- When the Constitution was amended in the year 2000 giving States a share in the Centre’s total tax pool.
- Centre will resort only sparingly to cesses and surcharges, and not as a matter of routine as has become the practice.
- States have felt cheated out of their legitimate share of national tax revenue: The next Finance Commission should lay down guidelines for when cesses and surcharges might be levied.
- Suggest a formula to cap the amount that can be raised.
- Government spending on freebies: All political parties are guilty on this count, some more than others, but trying to apportion blame will be a wrong start.
- The Finance Commission should formalize a mechanism for a restraint on freebies.
Way Forward
- In a poor country, where millions of households struggle for basic human needs, it sounds cruel to argue against safety-nets for the poor.
- We need to be more circumspect about freebies.
- The restraints imposed by the Fiscal Responsibility and Budget Management (FRBM) Act should have acted as a check on such populist spending, but governments have found ingenious ways of raising debt without it appearing in the budget books.
- The next Finance Commission should bite the bullet in the interest of long-term fiscal sustainability and lay down guidelines on the spending on freebies.
QUESTION FOR PRACTICE
How far do you think cooperation, competition and confrontation have shaped the nature of federation in India ? Cite some recent examples to validate your answer.(UPSC 2020) (200 WORDS, 10 MARKS)
