The 15th Finance Commission, which submitted its report for the FY22-FY26 period to the President on Monday, is learnt to have just about retained states’ aggregate share in the tax pool at the same level as by the previous Commission.
As in FY21, 41% of the divisible segment of central taxes may go to all states/UTs, except J&K and Ladakh and an additional 1% to the latter two in the five years to FY26. This is against a 42% share for all states including the then J&K, during FY16-FY20.
Further, the Consolidated Fund of India, where all revenues received by the Centre, including the divisible taxes and even the borrowed funds flow into, will have to expend a tidy sum each year during the 15th FC award period towards a dedicated special fund for modenisation of defence/internal security forces. This will effectively reduce the states’ tax receipts from the Centre even further.
Untied transfer of resources by the Centre to state governments hadn’t jumped during the 14th Finance Commission period (FY16-FY20) despite the sharpest hike ever (10 pps) in states’ share of divisible tax pool facilitated by the panel. This was partly because of the reduced revenue productivity in a slowing economy, but the Centre’s tactic of assuming a greater segment of the resource space through cesses and surcharges that are non-shareable also played a role in making the states’ hopes a mirage.
The NK Singh-led 15th Finance Commission seems to have struck a balance, even as the Centre, via the terms of reference given to it, apparently sought to influence its thinking, in order to avoid a further hike in states’ tax share, if not reduce it. The Commission’s recommendations could still deal a blow to the finances of all states during the next five years and some of them will be hit the hardest from the impact of its formula for horizontal distribution of divisible pool resources among states.
States, which have fared better than the Centre both in terms of fiscal consolidation and capital expenditure in recent years, came under great fiscal pressure in FY20 (they still managed to stick to targeted consolidated fiscal deficit-GDP ratio of 2.6% in the year thanks to sharp expenditure cuts). The pandemic has worsened their fiscal position in the current fiscal year (so far in the current fiscal year, 28 states and 2 UTs have cumulatively raised a total of Rs 4.27 lakh crore via market borrowings, 50% more than the borrowings in the corresponding period of 2019-20).
States are also worried over a yawning GST revenue shortfall, even though the Centre has agreed to provide a back-to-back loan facility for compensating them, which means the shortfall will be bridged with minimal cost to the states.
The 15th FC had in the last Budget session of Parliament submitted an interim report for FY21, where it kept tax devolution to states unchanged at 42% of the divisible pool after adjusting 1 percentage point for the needs of the erstwhile state of J&K. While J&K as a state would have got 0.85% share in the divisible pool, its share has been increased to 1% to cater to the rise in security related expenditures in the aftermath of bifurcation of the state into UTs of J&K and Ladakh. As far as vertical devolution is concerned, this formula is learnt to have been recommended by the commission for the FY22-FY26 period as well.
The 15th FC may have also continued with the FY21 norm of assigned a lower weight (15%) to ‘population’ than 27.5% assigned by the previous FC, giving a ‘respectable’ 12.5% to states that have performed well in population control, balancing the twin, seemingly conflicting parameters of ‘ current population’ and population control, for inter-se distribution of resources from the divisible tax pool. The interim report for FY21, which is being implemented by the government, continued with the practice of revenue deficit grants to a clutch of states; it is unclear if this grant will remain for FY22-FY26.
The FC said in a statement: “The Commission was asked to give its recommendations on many unique and wide-ranging issues in its terms of reference. Apart from the vertical and horizontal tax devolution, local government grants, disaster management grant, the Commission was also asked to examine and recommend performance incentives for States in many areas like power sector, adoption of DBT, solid waste management etc. The Commission was also asked to examine whether a separate mechanism for funding of defence and internal security ought to be set up and if so how such a mechanism could be operationalised. The Commission has sought to address all its ToRs in this Report to the Union government”.
According to the commission, its report has been organised in four volumes. Volume I and II, as in the past, contain the main report and the accompanying annexes. Volume III is devoted to the Union Government and examines key departments in greater depth, with the medium-term challenges and the roadmap ahead. Volume IV is entirely devoted to the States. The Commission has analysed the finances of each State in great depth and has come up with state-specific considerations to address the key challenges that individual States face.
The report will be available in the public domain once it is tabled in the Parliament during the Budget session. “I hope the 15th FC has strongly recommended an independent fiscal council to fill the institutional gap right now both at the central and state level,” said NR Bhanumurthy, Vice-Chancellor of Bengaluru Dr BR Ambedkar School of Economics University. Similar recommendations have also been made by NK Singh-led FRBM panel and 14th Finance Commission. Bhanumurthy, who has done a technical study on central tax devolution to states for the 15th FC, had suggested bringing lower devolution to states from 42% in 14th FC in order to enable the Centre to augment capex in order to revive economic growth.