Narendra Modi Must Stop Any 11th-Hour Attempt to Erode Fiscal Autonomy of States 

The centralising tendencies of the Fifteenth Finance Commission must be curbed.

When he was chief minister of Gujarat, Narendra Modi often vigorously argued for greater autonomy for states in terms of how they wanted to design their development programmes and spend their share of taxes. He even argued for state governments to be given the right to raise income tax. In short, he acted as a guardian angel of fiscal federalism.

But Narendra Modi as prime minister is behaving exactly the opposite. He now wants to centralise delivery of public goods to an extent that the states will be reduced to being mute implementing agencies for central programmes. Many states are deeply worried that a recent Presidential communication to the 15th Finance Commission has introduced a new term of reference at the eleventh hour, suggesting that a separate fund be carved out from the divisible pool of taxes and be specifically earmarked for internal security and defence related spending. 

States fear this is a red herring – and that the real purpose is to increase central discretion in use of funds.

This is unprecedented because so far all finance commissions have simply recommended a comprehensive formula to enable a portion of the divisible tax pool of taxes to be transferred to the states. Whatever the Centre retained would be used for central expenditure on national security, defence etc from the Consolidated Fund of India.

But seeking a special fund at the very last minute, that too after the Finance Commission has concluded its detailed consultations with all the states over the past few years, smacks of a unilateralism which has become a habit with this regime. The inherent suggestion that states must sacrifice part of their existing share of taxes (42% of the total pool) in the name of national security and defence may also indicate a certain desperation on the part of the Centre, which has clearly messed up its own fiscal balance sheet as was so evident in the recent Union budget numbers. Goods and Services Tax revenues not stabilising has added to the Centre’s anxiety.

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Indeed, weak GST revenue growth, at least 15 to 20% below what was originally projected, clearly reflects a sharply slowing economy, among other things. The Centre has now painted itself into a corner and wants to take away some of the states’ share of taxes. What better way of making it happen than through a constitutional body like the Finance Commission. Like all institutions, this one too will be under pressure to deliver. 

In 2015, Modi government had accepted the key recommendation of the 14th finance commission to increase the states’ share of taxes from 32% to 42%. This may seem like a big increase but fiscal experts suggest the real increase was much less (about 3%) because the 14th finance commission also subsumed other discretionary plan and non-plan grants which were received by states earlier. So the net benefit to States was not so great. 

In fact, in a paper titled ‘New Approaches to Fiscal Federalism in India’, former RBI governor Y.V. Reddy, who was also chairman of the 14th Finance Commission, has argued the percentage share to states in the four years – 2015-16 to 2018-19 – may actually be lower than during 2011-12 to 2014-15. 

This needs to be examined and analysed more closely because the Centre is now seeking to take back some of the existing share of the states’ revenue on the ground that the 14th Finance Commission was too generous to the states. 

But as per Dr Reddy’s analysis, supported by many other fiscal experts, this is just not true. The net share of states may not have increased at all.

The Centre’s machinations go against the spirit of the Constitution because Finance Commission is a constitutional body and cannot be used as an instrument of fiscal coercion by the Centre. The Modi government created a controversy from the very start when it set a very regressive terms of reference for the 15th Finance Commission. Modi’s centralising tendency was very visible in the unusual terms of reference issued.

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As Reddy notes in his paper, “The terms of reference of the 15th Finance Commission invited unprecedented controversies. Traditionally, the core functions of the Finance Commissions included a reference to providing grants for the States which are in need of assistance. This has been deleted. States genuinely fear that in the absence of need based revenue deficit grant, discretionary powers will be conferred on the Union which is contrary to the intent of the constitution.”

Further, the former RBI governor notes: “For the first time a specific mandate has been given to review the recommendations of the previous Finance Commission”. This is totally unprecedented and this intent is also reflected in the eleventh hour mandate that a special fund be carved out for defence and national security imperatives. The aim is to reduce the overall share of the States in the divisible tax pool.

The most unusual component of the term of reference, also outlined by Dr Reddy, is that for the first time the finance commission has been officially mandated to consider the various development and welfare programs launched by Modi under the rubric of “New India 2022”.

This means funds transfer to the states could be tied to how they participate and spend in the Centre’s flagship schemes such as PM Awas Yojna, Ayushman Bharat, universal tap water delivery and so on. Modi has already announced these schemes and the central budget has so far provided minuscule amounts for these schemes. These schemes need massive funding for full implementation. 

It seems clear Modi wants to use the instrument of the finance commission to push his pet welfare and development programs, packaged as ‘New India 2022’. Without doubt this will reduce the autonomy of states to design their own schemes as per their need. States may be just reduced to being implementation agencies.

In political economy terms, all of Modi’s ‘New India’ schemes are largely targeted at the Hindi heartland states which are real laggards in development and social indices but have given the BJP roughly 50% vote share in 2019 Lok Sabha elections. The sufferers will be the better off states, especially the South, which may not feel as compelled to commit itself to Modi’s New India. There will be serious dissonance here both in political and constitutional terms. 

The recommendations of the 15th Finance Commission, to be released in November, will be keenly awaited by many states only to see how much of their fiscal freedom will be taken away by Modi’s centralising regime.