Fiscal Federalism in India

Apart from separation of powers of taxation, constitution of India has provided for an institutional mechanism viz. Finance Commission for making recommendations to parliament on how the tax revenues between centre and states should be shared and how the imbalance can be corrected. Following are the related questions for analysis for this monograph on fiscal federalism.

What was the mandate of Planning Commission with respect to Fiscal Federalism? What were issues?

Planning Commission was set up in 1950 as an advisory and specialized institution charged with three major functions:

• Finalising the State plans and additional central assistance plans
• Act as a link between the centre and states
• Be an overarching guide to the states and the centre in respect of allocation of resources to different ministries for approved plan schemes

Establishment of planning commission as extra-constitutional body was based upon the premise that planning in India is a concurrent subject and creation of such body will strengthen the roots of Centre-State Cooperation and Indian federalism. Later in 1952, the National Development Council was established as an advisory body to the Planning Commission.

The role of Planning Commission in fiscal federalism can be discussed only for academic exercise in the light of following questions:

In context with fiscal federalism, the planning commission had the mandate of coordinating the development plans of the centre and the states in such a way that they conform to national objectives.

Further, planning commission was responsible for plan transfers or Central Planned Assistance (CPA) to the states. Under this, each state was allocated a portion of the total plan transfers which was tied to its development plan budget (part of the state budget; prepared by state governments) and was negotiable on a bilateral basis. These transfers were in addition to the funds available to states through the Finance Commission and Union Ministries (which were called non-plan transfers).

This worked for a while but gradually, started complaining of overarching powers of the Planning Commission for a long time. PM Narendra Modi himself was biggest critic of this commission. The major issues that were created were as follows:

• It was not acceptable for the chief ministers of the states being told by unelected officers in the Planning Commission where they should spend their money.
• The functions of planning commission collided with Finance Commission as well as Finance Ministry. For example, its role of serving as an intermediate between the centre and state collided with Finance Commission, which recommended on statutory transfers. Similarly, its role on non-discretionary transfers was almost nothing as there was a Gadgil Formula in place. Further, its role on residual discretionary allocation of resources to states was in effect nothing, because this is being done by the finance ministry.

However, despite this, the bilateral bargaining for plan approval continued year to year. With the advent of LPG era, the days of command economy were over and now it was time to replace planning commission with a new structure. {for details, read Rise and Fall of Planning Commission}.

One of the basic premises of establishing NITI Aayog was that it would promote fiscal federalism. Two years down the line, to what extent it has been successful towards that end?

The abolition of planning commission and doing away with the patronage system were two biggest reforms done by Modi Government in initial days of its current tenure. It put an end to the ritual pilgrimage of chief ministers to Yojana Bhawan to get their plan approved. Since centralized planning was a negation of the federalism, and there should be no reason why centre should approve state’s plans.

However, this reform was short of what was needed for the country. NITI Aayog has been established on the same premise on which planning commission was minus the annual ritual of plan approval. How this institution will evolve is yet to be seen. Some of its initiatives are as follows:

• The basic / core effort of NITI Aayog has been the creation of two hubs viz. Team India and Knowledge and Innovation Hub. While the Team India leads the engagement with states, the Knowledge and Innovation Hub is for building NITI Aayog’s think-tank capabilities. Overall, its a leaner than planning commission body. Under Team India, regular meetings of the CMs are held whereby cooperative federalism is emphasized.
• Unlike planning commission which looked economy from a national level approach, NITI Aayog targets sector wise implementation. It has tried to interlink the programmes with goal set by the government and works on major schemes on Agriculture, Digital India, Swachh Bharat, Skill Development etc.
• It has created task forces on elimination of poverty and farm development and an expert panel under Bibek Debroy gave a report to the centre on revamping the Indian Railways and merging the Railway Budget with Union Budget, this ending the British legacy.
• It is also trying to create a repository of best practices and data across the country.

Thus, within its capacity, the organization has tried to raise the hope to the idea of a developed India perhaps it would have been better if NITI Aayog was given a constitutional status. Two years down the line, we still lack a much needed institution for intergovernmental bargaining and conflict resolution and help the cause of cooperative federalism better.

What are key recommendations of 14^th Finance Commission and what is their implication for Fiscal Federalism?

The key recommendations of 14^th FC are as follows:

• Share of 42% of the divisible pool of tax to the states which is 10% more than the present share.
• Doing away with the distinction between unconditional and conditional transfers. Previously the transfers were a mix of conditional and unconditional funds, where the conditional transfers is given for serving some specific purpose. Here the state having the flexibility to utilize the conditional transfers as per the needs.
• Doing away with component of previous commission called fiscal discipline. Instead it introduced two new components that are changes in population between 1971 and 2011 and giving credit to the success in retaining forest cover. The other components to decide upon the share of state are – per capita income, traditional population and the areal considerations.
• Implementation of Goods and Services Tax and laid out a fiscal road map for the economy. A compensation mechanism to states for GST.
• Tax devolution should be the primary route for transfer of resources to the States.
• It has ignored the Plan and non-Plan distinctions
• Grants to States are divided into two (1) grant to duly constituted gram panchayats (2) grant to duly constituted municipal bodies.
• It has also divided grants into two parts (1) a basic grant, and a performance one for gram panchayats and municipal bodies. The ration of basic to performance grant is 90:10 for panchayats; and 80:20 for municipalities

Further, the 14^th FC had significantly departed from previous commission vis-à-vis recommendation of the principles governing grants-in-aid to the States by the Centre. It chose to take the entire revenue expenditure for this purpose. Hence, it has decided to take into account a state’s entire revenue expenditure needs without making a distinction between plan and non-plan expenditure. The Commission is of the view that sharing pattern in respect to various Centrally-sponsored schemes need to change. It wants the States to share a greater fiscal responsibility for the implementation of such schemes.