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Need for states to boost own tax & non-tax revenues
February, 26th 2014

While presenting Interim Budget 2014 last week, finance minister Palaniappan Chidambaram announced path-breaking fiscal devolution and decentralisation that his successor would do well to continue and follow through.

The Centre has decided to transfer funds amounting to Rs 2 lakh crore from the central plan and directly devolve to the state plans as central assistance.

The funding would be earmarked and used as per the guidelines framed by the Centre, but the states would also have a say to take into account local conditions, which should mean "greater authority and responsibility" for the latter in the development delivery mechanism.

However, the states do need to boost their own tax and non-tax revenues to provide greater resources for muchneeded social and physical infrastructure.

For, not doing so would veritably amount to being increasingly subject to what are really discretionary and formulaic grants and transfers decided by non-elected mavens. It points to the pressing need for the states to be much more proactive when it comes to fast-forwarding indirect tax reforms, namely, a comprehensive goods and services tax, so as to further rev up tax revenues in the states.

The change over to a value-added tax regime in the past decade did shore up consumption taxes on sales for the states. But the revenue upside going forward can be massive. Historically, the separation of taxes on production or central excise, and those on sales meant much cascading of the tax rates and a high-tax regime, effectively crowding out state taxes by evasion and other means.

There is also the need for the states to raise non-tax revenues, by levying proper user charges. And the latest figures suggest that while the tax ratio for higher-income states such as Karnataka and Tamil Nadu remains high, Gujarat is a laggard, with its own tax effort lower than that for Madhya Pradesh and even Uttar Pradesh.

The fact of the matter is that the game plan envisioned in the Interim Budget is to boost economic efficiency with greater decentralisation when it comes to intergovernmental transfers. And India's federal fiscal arrangements do mandate multiple channels for Centre-state transfers, including via Finance Commissions, the Planning Commission and various central ministries as well.

The Constitution does, after all, provide much greater powers of taxation and levies to the Centre, and a long list of spending and expenditure commitments for the states, including public order, health, education, transportation, agriculture and the like. Hence the vital need for what's termed "vertical fiscal transfers" to the states to correct the imbalance.

Yet, centrally sponsored schemes, now proposed to be labelled as central assistance in state plans, are no more than grants by various ministries to their counterparts in the states for various specified programmes. And grants and transfers can be rather discretionary. The Planning Commission does allocate grants for implementing the five-year development plans, which are now of an indicative nature rather than the top-down statist approach followed in the days of pre-reform right up to the 1990s.

But the transfers are formulaic indeed, with discretion exercised by what is a non-elected specialised body albeit set up by an Act of Parliament. The Constitution does provide for the setting up of an expert Finance Commission every five years for deciding on the share of the states in central taxes and provision for other grants, by what are deemed clear-cut objective criteria and based on the facts on the ground. But, here again, the weights assigned to the various parameters can be quite discretionary.

For instance, the weight for state population to decide on the devolution can change from 10 per cent to 25 per cent from one Finance Commission to the very next. Also, that for "index of infrastructure" can go down from 7.5 per cent to nil. Or, that for state income levels can drop from 62.5 per cent to no more than 50 per cent.

Broadly speaking, while the Finance Commission allocates about two-thirds of the transfers, the Plan panel and the ministries between them provide for about one-third.

The bottom line is that the states need to step up their own tax and nontax revenues to purposefully augment resources for their development and growth.

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