Why it is necessary to give power to the states, but exercise caution

By: Saumitra Chaudhuri

Dr Y V Reddy has left a firm imprint in analysis, observations and recommendation of the 14th Finance Commission (FFC) report. It'll be remembered for the massive escalation in the states' share of the divisible pool, from 32% to 42%. It has achieved this by taking away from the fiscal space previously enjoyed by the Plan, particularly centrally sponsored schemes (CSS), an object (like everything else) started with the best of motives, but which became a means for central ministries to seek control in a domain that of states, by constitutional arrangement and precedence; and one of complaint from the states.

The FFC makes a telling comment: "We've noted the concern expressed by states regarding the . . . intervention of the Union government in subjects in the State List on account of the widening ambit (often conditional) of CSS". To such an extent that later the report notes that as the share of revenue expenditure by the Centre on subjects on the State List increased from 14% to 20% and that on the Concurrent List from 13% to 17%, the share of expenditure on subjects on the Union List fell from 66% to 53% between 2001-02 and 2014-15.

The FFC says notwithstanding previous finance commission recommendations on a prescriptive ceiling on total transfers the Centre routinely exceeded it by expanding the CSS. Such that about half its total revenue receipts (including non-tax) were being transferred to states in the period 2010-11 to 2014-15.

So even as it raised states' share of the divisible pool of taxes to 42% and provided for other grants, it retained significant resources for the Centre to devolve to states in a "new institutional mechanism" — shorthand for replacement of what used to be Plan transfers, albeit at a lower level than in the recent past. The overall transfers to states which the FFC recommended — one that'll provide "appropriate fiscal space to the Union to carry out its constitutionally assigned expenditure responsibilities" — is at 49% of gross domestic receipts — about the same as was effectively in operation in five years. There's a shift in favour of tax share, which as the FFC notes states view as "their rightful share" against CSS which so-metimes look- ed like favours dispensed.

But the FFC report isn't just about resource sharing: There's much more that's interesting. It's spiked the concept of "effective revenue deficit" which it calls "artificial", but stops short of calling it an artifice. It has recommended that this innovation be dropped by legislation as it can encourage creative accounting. Fiscal policy and stance play a powerful role in creating an atmosphere conducive to investment and growth. Clever word games are self-defeating — they erode credibility. Especially in a context where someone in authority wants to set up ra- ting rules, since the established rating agencies are "unfair" or a retrospective tax law amendment is made after government loses its case in Supreme Court. Governments make rules: They should never bend them to suit them.