By Dr Sudhakar Panda*

The Fourteenth Finance Commission was constituted by the President of India with Dr. Y. V. Reddy, former Governor of the Reserve Bank of India as its Chairman. Prof Abhijit Sen, Member, Planning Commission, Ms. Sushama Nath, Former Union Finance Secretary, Dr. M. Govinda Rao, Director, National Institute for Public Finance and Policy, New Delhi and Dr. Sudipto Mundle, Former Acting Chairman, National Statistical Commission were the eminent Members of the Commission. Shri Ajay Narayan Jha was the Secretary to the Commission.

The terms of reference of the Fourteenth Finance Commission are conventional, but a number of additional terms of reference do enable it to break some new ground. It hopes that the FFC will restore horizontal federal fiscal equity in the distribution of revenues and recommend special financial assistance to big cities that face an unprecedented pressure on urban services.

Finance Commissions in India: It was in the year 1951 that the first Finance Commission of India came into existence. Article 280 of the Indian Constitution makes it mandatory that there shall be a Finance Commission in India once in every five years to look into the financial relations between the Central Government and the State Governments. The need for setting up of the Finance Commissions in India arose for the fact that Indian federation suffered from the problems of both vertical imbalances and the horizontal imbalances. It was Dr. B. R. Ambedkar, the Father of the Indian Constitution who could foresee the need for the Finance Commission as there existed on the one hand (i) a vertical imbalance between the Union Government and the State Governments and on the other hand there was the existence of (ii) horizontal imbalance among the Indian states which were at different levels of development at the time of independence.

It becomes evident that the states in India which have been assigned important responsibilities for the development of their economies and are close to the people to appreciate and deal with their problems suffer from paucity of funds. Sources of revenues assigned to the States are inelastic in nature and would not generate enough resources to enable the states to perform their ever growing functions satisfactorily. On the contrary sources of revenues assigned to the Union Government in contrast to the sources of revenues available to the States are more productive and elastic. They could be expected to yield more of revenues to the Centre with the growth of the economy. There would be therefore a considerably large resource gap between the Centre and the States. There is thus the need to bridge the resource gap between the Centre and the States for the healthy growth of the nation.

Corresponding to the vertical imbalance between the Centre and the States, the States among themselves suffer from what is called the horizontal imbalance. The problem of horizontal imbalance exists as the Indian states at the time of independence and subsequently at the time of merger were at different levels of economic development. Depending on the status of their development, the states had their own sources of revenues. Developed states like Maharashtra, Gujarat, Punjab and Haryana were better placed to mobilize more resources than the poorer states like Odisha and Bihar. In other words the states in the Indian Federation were placed with different degrees of access to the sources of revenues. This makes it imperative for the Union Government to offer financial assistance to the less developed states by taking care of such horizontal imbalances.

How do we solve the twin problems of vertical and horizontal imbalances? There could not be a better mechanism to address these problems between the Union and the States (the problem of vertical imbalance) and among the states (the problem of horizontal imbalance) on the other except through a constitutional mechanism. This is where the foresight and wisdom of Dr.B R Ambedkar proved very helpful.

The First Finance Commission was set up in 1951. Since then we have travelled a long way. The Fourteenth Finance Commission which was set up under the Chairmanship of Dr. Y V Reddy submitted its recommendations to the Government of India.

The Finance Commissions in India are normally asked to determine the principles of distribution of the net proceeds of taxes between the Centre and the States and determine the principles for giving grants to the states. The President of India may also refer any other matter in the interest of sound finance. The Fourteenth Finance Commission was asked to suggest changes to the Fiscal Responsibility and Budget Management (FRBM) Act and assess the impact of the proposed Goods and Services Tax (GST) on government finance and suggest a mechanism to compensate the states for the loss of revenue, if any. Its recommendation would help the Government of India in taking a decision in the matter.

An important area where the views of the Fourteenth Finance Commission were solicited referred to the pricing of public utility services like the drinking water, irrigation, power and public transport and how to insulate their pricing “from policy fluctuations through statutory provisions.”A very sensitive issue that also came up for the views of the Commission related to the growing size of subsidies in India and the problem sharing of the subsidies between the Union government and the States.

Provision of continuous subsidies to the people has been a very sensitive issue. It is linked to as much to the poverty of the people as much as to vote bank politics. While the continuation of food subsidies has to be considered in the context of India’s approach and commitment to food security and inclusive growth, the problem of leakages cannot be ignored. It is reported that in many cases families have been split to claim the benefit. Even the most ineligible families in villages have been enjoying the access to subsidized rice. This has put an unjustifiably big financial burden on Union and the state governments.

Deliberations of the 14th Finance Commission:

It may be interesting to note that the Commission for the first time added a new criterion of forest cover for devolution of Central taxes. The panel assigned 7.5 per cent weight to forest cover for inter-se determination of the shares of taxes to the states. The Commission justified the award saying, “We believe that a large forest cover provides huge ecological benefits, but there is also an opportunity cost in terms of area not available for other economic activities and this also serves as an important indicator of fiscal disability.” This is expected to provide financial stimulus to the states to protect and increase their forest cover.

Odisha which has maintained its forest cover at 37.34 per cent of its geographical area (Odisha Economic Survey; 2013-14,p: 100) may stand to gain from the approach of the Commission. This is a recognition of the sustained efforts of the state to protect its rich forest cover vis-à-vis the forest cover in the country.

The other criteria which the Commission adopted for tax devolution to the states is population (1971 Census), demographic change (2011 Census), area and income distance. It may be interesting to note that the weight age given to population, demographic change; area and distance from the highest per capita income are 17.5 per cent, 10 per cent, 15 per cent and 50 per cent respectively. Size of population of different states has always been an important consideration for the Finance Commissions in India.

The 14th Finance Commission is aware of the limitations of considering states’ population as per the 1971 Census as a factor for deciding the devolution of funds for the award period 2015-20. It could have been criticized as unreasonable and untenable in view of large changes in the size of population experienced by the states. One cannot ignore their impact on state finances and on states’ planning for development of the social sector including the development of education and health for the disadvantaged sections of their population. This has been taken care of by considering the demographic change as per the 2011 Census. Geographical area of the states is a given factor. No states would contend this issue. Besides in India we have small states like Goa as there are also large states like UP and MP.

Large states have bigger responsibilities in terms of administration of larger areas, maintenance of law and order and development compared to the smaller states which because of their small size do not have the in-built disadvantages of the big states. Hence the area factor has been given a bigger weight age than population. Size of per capita income of different states is normally taken as indicative of the respective levels of development of the Indian states. This has also been taken into consideration by the Fourteenth Finance Commission for the purpose of devolution of funds from the Central Government to the States. Adoption of this yardstick by the Commission may prove helpful for the states like Odisha and Bihar which suffer from a considerable distance from the highest per capita income of the developed states like the Punjab and Haryana.

Recommendations of the Fourteenth Finance Commission:

The Fourteenth Finance Commission whose recommendations cover a period of five years from 1915-16 to 1919-20 was expected to deliberate on all important issues placed before it by the State Governments, State Finance Commissions, Trade and Business Bodies and important personalities. The Commission may also visit the Indian states and hold discussions with the different departments of the state governments on issues against which states might have pleaded for more grants. As a member of the Second State Finance Commission and as the Chairman of the Third State Finance Commission I had the privilege of presenting the case of Odisha before the Twelfth Finance Commission under the Chairmanship of C. R. Rangarajan and the Thirteen Finance Commission under the Chairmanship of Vijay Kelkar for their considerations.

It may be noted that the recommendations of the 14th Finance Commission have been well received by the states.

Share of the states from the divisible pool of the central taxes for the period 2015-16 to 2019-20 has been raised significantly to 42 per cent as against the share of 32 per cent recommended earlier by the Thirteenth Finance Commission. It has been estimated that states in 2015-16 will receive Rs.5.79 lakh crore from the expected gross tax receipts of Rs.15.67 lakh crore accruing to the Centre. Compared to the devolution of states’ share in 2014-15 from the divisible pool of the central taxes, there will be an increase in states’ share to the tune of 51.55 per cent in 2015-16. It may thus be noted that the Reddy Commission favors the states with larger devolution of funds from the Union Government. The Commission has recommended a devolution of Rs.39.48 lakh crore of tax receipts from the Centre to the states in the next five years.

It may also be stated that the Reddy Commission has recommended grants to the states to the tune of Rs.5.37 lakh crore. This makes a significant change to the flow of funds from the Centre to the states. If this is taken into consideration then the total devolution to the states will increase to 47 per cent of the divisible pool in the next five years; that is from 1915-16 to 1920-21. This compares very favorable for the states as against the earlier recommendation of 39.5 per cent by the Thirteenth Finance Commission.

It is feared in many quarters that the recommendations of the Commission to allow increased devolution of funds to the states may result in reducing the fiscal space for the Union Government. The Finance Ministry, Government of India observed that “This (the recommendations) naturally leaves far less money with the Central Government”. In other words as a consequence of greater devolution to states the fiscal space of the centre will be reduced. But the 14th Finance Commission is of the opinion that even after this increased devolution of funds to the states; the central government would have during the five year period as much Rs.49.14 lakh crore left from the divisible pool. The fiscal deficit of the Union Government will be at 3.6 per cent in the next financial year and would gradually be reduced to 3 per cent in the next four years.

It may also be noted that for the first time the 14th Finance Commission recommended while considering grants to the states to do away with the distinction between Plan and Non-Plan expenditure.

The other important recommendations of the 14th Finance Commission refer to the setting up of “an independent council to undertake assessment of fiscal policy implications of Budget proposals and replace the FRBM Act with a debt ceiling and fiscal responsibility law”. It also recommended states to augment their own revenues, to have
The Commission also recommended“ to wind up the National Investment Fund and maintain all disinvestment receipts in the Consolidated Fund”.

The Commission in its report also suggested performance based grants to Panchayats and Local Bodies in the ratio of “basic- to-performance grant to be kept at 90:10 for Panchayats and 80:20 for Municipalities”. The Commission was very considerate to suggest a grant of Rs.1.9lakh crore to 11 states that may record revenue deficits following the acceptance of its recommendations. This would amount to 36.25 per cent of the total grants to the states for the five year period.

It is expected that with increased devolution of funds to the states, the states would be less critical of the Centre and would in a better position to undertake their own development programmes.

*Prof. [Dr] Sudhakar Panda is an economist and was the chairman of the third Odisha State Finance Commission.