Debate: The Fifteenth Finance Commission is Vital for Economic Equality Within the Indian Union

It would be utterly unjust to expect that better off states be “rewarded” with more central revenues in addition to their already increased state tax revenues.

While some of the terms of reference of the 15th FC should be ironed out, the advantages of India as a political and economic union should not be so easily dismissed. Credit: PTI

While some of the terms of reference of the 15th Financial Commission should be ironed out, the advantages of India as a political and economic union should not be so easily dismissed. Credit: PTI

For fans of schadenfreude, Britain’s “brexit” shambles has provided much fodder over the last eighteen months or so. As the members of the campaign to leave the European Union are beginning to find out, the task of leaving an economic and political union is immense with unforeseen problems cropping up every other day. All the promised dreams of increased revenues and independence are evaporating the in the face of the harsh realities of what promises to be a messy divorce.

It is in this context that one must appreciate the somewhat apocalyptic claims made by R.S. Nilakantan in his article on the fifteenth finance commission in The Wire.

The claim made, broadly, is that the fifteenth commission’s proposal to use the 2011 Census figures as the basis to allocated union tax revenues will adversely affect the ability of Tamil Nadu and Kerala to provide an effective welfare state for their residents. The basis for this claim is that southern states have (through a combination of improved health and education) reduced birth rates and total fertility rates far more than the northern states, and allocating union tax revenues on the basis of population will “punish” the southern states for following sensible policies.

Nilakantan uses data to show how much Tamil Nadu has “lost” in terms of union tax revenue out of the divisible pool as a result of the 14th Finance Commission’s recommendations giving 10% weightage to the 2011 population of a state in determining how much tax revenue a state will receive. His argument is that if 27.5% of weightage is given over to the population of states as of 2011, and if the same method is carried forward in future years, states which have lower TFRs will suffer in comparison to states which have higher TFRs insofar as allocation of union tax revenues is concerned.

A few things need to be clarified. Merely because the terms of reference of the commission require it to use 2011 census data does not mean that it cannot use any other census data or necessarily give it the weight that Nilakantan assumes that it will. The Fourteenth Finance Commission’s TOR also had a clause requiring it to use the 2011 census data but after consultations and discussions with relevant stakeholders, the 2011 census data was given only 10% weightage and the 1971 census data 17.5% weightage. There is no basis to assume that the weightage will be as high as 27.5% or that they will not take other census data into account.

Furthermore, it is not as if the terms of reference are totally blind to the notion that a state improving the TFR should be encouraged – the commission is also mandated to come up with “measurable performance based incentives” in the progress made by a state towards replacement rate of population growth. Taking these into account, one would think that the concern that states which have managed to reduce their TFRs would be necessarily “punished” by the recommendations of the Fifteenth Finance Commission is somewhat overblown. There are, however, other concerns with the FC’s TOR, specifically the importance it seem to give union schemes over state ones but those are not part of the present discussion.

The terms of reference notwithstanding, in understanding the implications of the report of the Fifteenth Finance Commission, we need to see Nilakantan’s data in proper context.

First, a few facts. States have two broad sources of revenue – taxes levied and/or collected by them and share in union taxes under the Constitution. It is only a part of the latter that is divided in accordance with the Fifteenth Finance Commission recommendations. States also receive discretionary grants from the union, usually in pursuance of its schemes. The FC’s recommendations also lay out principles on the basis of which such grants are made.

Not all states are equally dependent on union tax revenues. The chart below shows, on the basis of the latest data available, how much each state is dependent on union revenues, as a percentage of overall revenues of the state in the latest financial year for which data is available.

States Year State’s own Tax (in Rs Crore) State’s own non-Tax Share in Central Taxes Grants-in-aid from Centre Total % own revenues % revenues from the Centre
Nagaland 2016-17 revised) 479 236 8640 9355 7.64% 92.36%
Mizoram 2016-17 Revised) 366 282 2801 4441 7889 8.21% 91.80%
Tripura 2016-17 revised) 1410 251 4100 7007 12768 13.01% 86.99%
Meghalaya 2016-17 Revised) 1268 466 3669 3577 8980 19.31% 80.69%
Sikkim 2016-17 revised) 628 396 2233 1937 5195 19.71% 80.27%
Bihar 2016-17 revised) 27897 2384 58881 38376 127537 23.74% 76.26%
Jammu & Kashmir 2016-17 revised) 8442 5224 9500 27008 50174 27.24% 72.76%
Assam 2016-17 revised) 12328 4513 19243 22923 59008 28.54% 71.46%
Himachal Pradesh 2016-17 Revised) 7217 1510 4333 13615 26676 32.71% 67.28%
West Bengal 2016-17 revised) 48926 2038 44625 33750 129340 39.40% 60.60%
Odisha 2016-17 revised) 23200 8823 28321 19639 79983 40.04% 59.96%
Madhya Pradesh 2016-17 revised) 44135 10410 46064 25441 126051 43.27% 56.73%
Uttar Pradesh 2016-17 revised) 90219 27575 102650 48964 269407 43.72% 56.28%
Manipur 2016-17 Budget Estimates) 4229 191 4947 9367 47.19% 52.81%
Jharkhand 2016-17 revised) 19900 11258 21034 13414 65607 47.49% 52.51%
Chattisgarh 2016-17 revised) 22734 7520 18809 13722 62786 48.19% 51.81%
Uttarakhand 2016-17 revised) 10866 1316 6411 6661 25254 48.24% 51.76%
Andhra Pradesh 2016-17 revised) 49282 4500 26264 27663 107709 49.93% 50.07%
Rajasthan 2016-17 revised) 46986 12469 33555 23416 116426 51.07% 48.93%
Karnataka 2016-17 revised) 82211 7099 28760 14798 132867 67.22% 32.78%
Telangana 2016-17 revised) 50126 8510 14877 13557 87070 67.34% 32.66%
Kerala 2016-17 revised) 44548 10057 15225 10790 80620 67.73% 32.27%
Tamil Nadu 2016-17 Revised) 87287 11266 24537 20708 143799 68.54% 31.46%
Maharashtra 2016-17 revised) 137230 16619 33715 32447 220012 69.93% 30.07%
Gujarat 2016-17 revised) 64759 14378 18835 14548 112521 70.33% 29.67%
Punjab 2016-17 revised) 30251 6260 9599 5259 51371 71.07% 28.92%
Haryana 2016-17 revised) 37841 7245 7337 7901 60327 74.74% 25.26%
Delhi 2016-17 revised) 32430 456 0 4036 36922 89.07% 10.93%

(Source: Respective state budget documents) (Nagaland and Manipur gave no split for share in central tax revenues and grants)

The FC’s recommendations would therefore affect only the distribution of union revenues among the State and cannot affect how much revenue a State raises through its own taxes.

A caveat is necessary here: even the above data may not be very relevant going ahead given that it is not yet known how the chips will fall once the GST regime becomes stable. Initial data suggests that it might favour well off states (like Tamil Nadu and Maharashtra) more than poorer states like Bihar given that consumption is also higher, being economically better off states.

It is also necessary to re-iterate here that there is no legal or constitutional basis for claiming that merely because a state is the place at which union tax returns are filed, it should get exactly the same share of union taxes. Although Nilakantan does not make this claim explicitly, there are others who have. Short of abolishing the union’s power to impose taxes entirely, this is not a feasible idea. To illustrate with an example, merely because Indigo, headquartered in Gurugram but offering its services across India, it is highly questionable if Haryana should automatically get the full share of the income taxes and Central GST paid by Indigo just because it happens to file its returns from there. Would it be possible to say that central taxes paid on Indigo’s flights between Mumbai and Bengaluru should automatically accrue to Haryana simply because Indigo’s headquarters are in that state?

The positives of India being a political and economic union must not be dismissed so lightly. In the international context, the problems of taxation across jurisdiction are usually resolved through a double taxation avoidance agreement which divides taxing powers between signatory states.

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States in India don’t need to enter into double taxation avoidance treaties, don’t need regional conventions to set common minimum standards for businesses, don’t require businesses to register subsidiaries in order to be able to do businesses not are they required to individually negotiate for all these things with other countries. Labour can be hired across state boundaries without visas and permits, raw material transported easily without import barriers and goods exported likewise. All of these are constitutionally guaranteed as part of a “bargain” which also determines how union tax revenues are to be split between states, among other things.

While there is political equality between the federating units of the Indian union, a mechanism such as the finance commission is to ensure that there is some level of economic equality as well.

In this context, it makes eminent sense that the division of union revenues to the states is need-based – which states need it more to ensure all round development. India seems to be bucking the international trend of increasing economic growth resulting in convergence of incomes between regions. The ‘3-3-3’ problem – that is, Indians living in the three richest states are three times as rich as those living in the three poorest states – is not going away any time soon and the causes for this are not easy to pin down.

In this scenario, it would be utterly unjust to expect that the better off states be “rewarded” with more central revenues, in addition to their already increased state tax revenues. Even between states, the Fifteenth Finance Commission should avoid a situation where all the wealth is concentrated in a few states as the rest struggle to provide basic services and life people out of poverty. It’s hard to imagine a union of states with such immense disparities between regions surviving for too long as one.

Alok Prasanna Kumar is Senior Resident Fellow, Vidhi Centre for Legal Policy.

R S Nilakantan responds:

  • What if reduction in fertility rates is featured as a new factor in the 15th Finance commission’s formula: the original piece addresses this explicitly.  If it does, even in the best of cases, it’d be a mathematically complicated way of doing nothing to create a negative residual and then erase it. The divergence in population growth is too large to envision such a factor working meaningfully. Tamil Nadu for instance had roughly the same population as Bihar did in 1971. In 2011, the latter had almost 30 million more people. That difference alone is roughly the population of Malaysia!
  • Alok’s central argument is to treat all of India as a unit of political discourse and treat the states as some entities that exist in order to make the country up. These are societies that are often larger than many mid-sized countries. The constitutional basis, whatever it may be, is irrelevant. If laws are unfair, we can change them. That’s why democracies exist.
  • The thrust of the original piece is: is it fair to have a system where demographic divergence is used as a factor for increasing the share of divisible pool after having urged states across the union to aggressively implement family planning? That is to change the rule of the game after someone had made significant progress. This change in rules post-facto, most reasonable people will agree, is unfair.
  • Alok says that India provides a market to manufacturing states like Tamil Nadu. Sure it does. But to assume that market exists only because Tamil Nadu exists within the union is to ignore the fact that countries that are far smaller than Tamil Nadu and Kerala’s size with lower indices in educational achievement don’t merely exist but thrive. This is exactly the problem that Sir Tom Devine addresses in his book Independence Or Union: Scotland’s Past And Scotland’s Present that was cited in the original piece.

Alok’s overall argument seems to be: the cost of staying in the union is paying for demographic divergence through loss of fiscal autonomy and states’ rights. That is both deeply undemocratic and economically unviable.