By R Gopalan and MC Singhi
Cooperative fiscal federalism works effectively in the belief that different tiers of government function efficiently through collaboration among themselves. Their interactions occur under rules that are transparent, consistent, and unambiguously known to all participants. However, we see an asymmetry in allocation of resources and expenditure responsibilities among the different tiers of government. This requires an optimal resource transfer mechanism to facilitate delivery of services at different tiers so that the right incentives are provided to each tier for maximising welfare.
The states, however, believe that the asymmetry envisaged in the Constitution has accentuated beyond the levels contemplated and tilted in favour of the central government. The better-off states are concerned that the transfers are unduly biased against them and that would create a situation of adverse incentives. First, this is because of treating different sets of receipts as independent rather than fungible and a part of the whole, such as non-tax receipts being not a part of the divisible pool and increasing recourse to cess and surcharges. Second, the criteria being followed for interstate allocation of resources have often ignored their contribution to resource generation and genuine expenditure commitments. The first issue was recognised by the 14th Finance Commission, which rightly observed that in resource transfers it is necessary to consider resources and expenditures for both the Union and the states by creating an appropriate fiscal space at each tier.
Also Read Turbocharging start-ups: Turn job-seekers into job-creators Higgs and lows of academia More incomes in the tax net Regulating AI
There have been significant changes in the nature and quantum of transfers to the states. Prior to the recommendation of the 10th Finance Commission, only the proceeds of income tax and excise duties were sharable. The 10th Finance Commission recommended global sharing of tax receipts, which has since continued with an increase in the share of states from 26% to 42%. Overall share of states in gross revenue receipts of the Union has increased post-14th Finance Commission to average 51% in the past decade. The share of taxes, as entitlement, reached an average of 29% of gross revenue. Another 22%, discretionary in nature, is by way of grants. Notwithstanding the overall increase, inter-se transfers among different categories of states is biased in favour of the less advantaged ones. Some broad characteristics of resource transfers are indicated in the table.
The table reveals that for NE and more disadvantaged states, transfers account for a bulk of their revenue receipts. While tax transfers are more biased in their favour, discretionary transfers in terms of grants and schemes are more equitably distributed. Further, during 2014-2022, the overall resources largely maintained a reasonable growth for all category of states thanks to greater buoyancy of transfers from the Union. The buoyancy of the states’ own resources was less than unity and it had significantly eroded for the states in the southern region.
The bias in favour of backward states was purposive and encouraged by successive Finance Commissions (FCs). Their criteria for distribution of the divisible pool between the states significantly allocated higher weights to backwardness defined as distance from the best state in terms of per capita income. The idea behind such purposive bias was to compensate these states for their low fiscal capacity and to maintain a uniform level of civic amenities. Higher allocation would facilitate more inflow of private and government investment helping them to catch up in terms of personal incomes. This bias has persisted for over 70 years now. The outcome, however, is not unambiguously in favour of this purposive bias. The per capita income of backward states compared to the average of all states declined from 67% in 2000-01 to 61% in 2021-22. For NE states, it declined from 87% to 77%; for the better-off states, it increased from 132% to 143%. The southern region showed a better performance in this period. Their per capita GSDP increased from 124% of all states to 158%. On civic amenities, the overall Sustainable Development Index shows a much better performance for the better-off states.
In view of this, there is a need to review the mechanism of transfers and the criteria governing such transfers. Discretionary transfers are more equitable and better targeted; it may be worthwhile considering more such transfers. A body like the Office for Budget Responsibility in the UK can balance the bias in such transfers. Further, to incentivise raising own resources in backward states, the FC can allocate a percentage of divisible pool in proportion to own resources raised. This will indirectly provide the better-off states a better share in resources raised in their domain area. We need to reduce the apprehension that those who contribute to resource generation have a limited share in their use. Such allocation will facilitate greater capital formation and better resource management. It will force states to focus on raising their own resources rather than seeking fiscal packages.
The authors are former civil servants.
Disclaimer: Views expressed are personal and do not reflect the official position or policy of Financial Express Online. Reproducing this content without permission is prohibited.
By R Gopalan and MC Singhi
Cooperative fiscal federalism works effectively in the belief that different tiers of government function efficiently through collaboration among themselves. Their interactions occur under rules that are transparent, consistent, and unambiguously known to all participants. However, we see an asymmetry in allocation of resources and expenditure responsibilities among the different tiers of government. This requires an optimal resource transfer mechanism to facilitate delivery of services at different tiers so that the right incentives are provided to each tier for maximising welfare.
The states, however, believe that the asymmetry envisaged in the Constitution has accentuated beyond the levels contemplated and tilted in favour of the central government. The better-off states are concerned that the transfers are unduly biased against them and that would create a situation of adverse incentives. First, this is because of treating different sets of receipts as independent rather than fungible and a part of the whole, such as non-tax receipts being not a part of the divisible pool and increasing recourse to cess and surcharges. Second, the criteria being followed for interstate allocation of resources have often ignored their contribution to resource generation and genuine expenditure commitments. The first issue was recognised by the 14th Finance Commission, which rightly observed that in resource transfers it is necessary to consider resources and expenditures for both the Union and the states by creating an appropriate fiscal space at each tier.
There have been significant changes in the nature and quantum of transfers to the states. Prior to the recommendation of the 10th Finance Commission, only the proceeds of income tax and excise duties were sharable. The 10th Finance Commission recommended global sharing of tax receipts, which has since continued with an increase in the share of states from 26% to 42%. Overall share of states in gross revenue receipts of the Union has increased post-14th Finance Commission to average 51% in the past decade. The share of taxes, as entitlement, reached an average of 29% of gross revenue. Another 22%, discretionary in nature, is by way of grants. Notwithstanding the overall increase, inter-se transfers among different categories of states is biased in favour of the less advantaged ones. Some broad characteristics of resource transfers are indicated in the table.
The table reveals that for NE and more disadvantaged states, transfers account for a bulk of their revenue receipts. While tax transfers are more biased in their favour, discretionary transfers in terms of grants and schemes are more equitably distributed. Further, during 2014-2022, the overall resources largely maintained a reasonable growth for all category of states thanks to greater buoyancy of transfers from the Union. The buoyancy of the states’ own resources was less than unity and it had significantly eroded for the states in the southern region.
The bias in favour of backward states was purposive and encouraged by successive Finance Commissions (FCs). Their criteria for distribution of the divisible pool between the states significantly allocated higher weights to backwardness defined as distance from the best state in terms of per capita income. The idea behind such purposive bias was to compensate these states for their low fiscal capacity and to maintain a uniform level of civic amenities. Higher allocation would facilitate more inflow of private and government investment helping them to catch up in terms of personal incomes. This bias has persisted for over 70 years now. The outcome, however, is not unambiguously in favour of this purposive bias. The per capita income of backward states compared to the average of all states declined from 67% in 2000-01 to 61% in 2021-22. For NE states, it declined from 87% to 77%; for the better-off states, it increased from 132% to 143%. The southern region showed a better performance in this period. Their per capita GSDP increased from 124% of all states to 158%. On civic amenities, the overall Sustainable Development Index shows a much better performance for the better-off states.
In view of this, there is a need to review the mechanism of transfers and the criteria governing such transfers. Discretionary transfers are more equitable and better targeted; it may be worthwhile considering more such transfers. A body like the Office for Budget Responsibility in the UK can balance the bias in such transfers. Further, to incentivise raising own resources in backward states, the FC can allocate a percentage of divisible pool in proportion to own resources raised. This will indirectly provide the better-off states a better share in resources raised in their domain area. We need to reduce the apprehension that those who contribute to resource generation have a limited share in their use. Such allocation will facilitate greater capital formation and better resource management. It will force states to focus on raising their own resources rather than seeking fiscal packages.
The authors are former civil servants.
Disclaimer: Views expressed are personal and do not reflect the official position or policy of Financial Express Online. Reproducing this content without permission is prohibited.
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Secular bias in resource transfer
12
65
20.04.2024
By R Gopalan and MC Singhi
Cooperative fiscal federalism works effectively in the belief that different tiers of government function efficiently through collaboration among themselves. Their interactions occur under rules that are transparent, consistent, and unambiguously known to all participants. However, we see an asymmetry in allocation of resources and expenditure responsibilities among the different tiers of government. This requires an optimal resource transfer mechanism to facilitate delivery of services at different tiers so that the right incentives are provided to each tier for maximising welfare.
The states, however, believe that the asymmetry envisaged in the Constitution has accentuated beyond the levels contemplated and tilted in favour of the central government. The better-off states are concerned that the transfers are unduly biased against them and that would create a situation of adverse incentives. First, this is because of treating different sets of receipts as independent rather than fungible and a part of the whole, such as non-tax receipts being not a part of the divisible pool and increasing recourse to cess and surcharges. Second, the criteria being followed for interstate allocation of resources have often ignored their contribution to resource generation and genuine expenditure commitments. The first issue was recognised by the 14th Finance Commission, which rightly observed that in resource transfers it is necessary to consider resources and expenditures for both the Union and the states by creating an appropriate fiscal space at each tier.
Also Read Turbocharging start-ups: Turn job-seekers into job-creators Higgs and lows of academia More incomes in the tax net Regulating AI There have been significant changes in the nature and quantum of transfers to the states. Prior to the recommendation of the 10th Finance Commission, only the proceeds of income tax and excise duties were sharable. The 10th Finance Commission recommended global sharing of tax receipts, which has since continued with an increase in the share of states from 26% to 42%. Overall share of states in gross revenue receipts of the Union has increased post-14th Finance Commission to average 51% in the past decade. The share of taxes, as entitlement, reached an average of 29% of gross revenue. Another 22%, discretionary in nature, is by way of grants. Notwithstanding the overall increase, inter-se transfers among different categories of states is biased in favour of the less advantaged ones. Some broad characteristics of resource transfers are indicated in the table.
The table reveals that for NE and more disadvantaged states, transfers account for a bulk of their........
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