For a fair share

ON June 9, Union Finance Minister Arun Jaitley, speaking at a pre-Budget consultation with the Finance Ministers of States and Union Territories, stressed the need for the Centre and the States to complement each other in reviving the economy and the fiscal policy. “This is the essence of cooperative federalism. It has been noted that while the growth of the country has crawled at sub-5 per cent in recent years, there have been States registering much robust growth. This is clearly a case of the sum being less than its parts and needs to be addressed through our concerted efforts,” Jaitley said.

The memoranda submitted by 13 States, including those ruled by the Bharatiya Janata Party (BJP) and the Congress, to the 14th Finance Commission over the past few months, however, show that the States’ share of the Central tax revenue was not adequate in meeting their non-Plan expenditure commitments during the Eleventh Plan period (2007-08 to 2011-12). This proved to be a serious challenge in public funding in the areas of education and health and forced State governments to cut down on the expenditure on staff and human resources. (Non-Plan expenditure includes additional expenditure outside of the planned schemes approved by the Planning Commission. These include interest payments, pension payments and other expenditure incurred to successfully carry out developmental activities.) The States have thus demanded a higher share of the Central tax revenue in order to be able to meet their non-Plan expenditure commitments.

The Finance Commission is mandated to determine the distribution of tax proceeds between the Centre and the States. The 14th Finance Commission was constituted in January last year. Its terms of reference include distribution between the Union and the States of the net proceeds of taxes which are to be divided between them and the allocation between the States of the respective shares of such proceeds. The commission will submit its report in October 2014.

Shrinking share

In the revised estimates for 2012-13, the States’ share in gross the Central tax revenue was 28.1 per cent. In December 2009, the 13th Finance Commission Report recommended that the States’ share in the net proceeds of Central taxes shall be 32 per cent in each of the financial years from 2010-11 to 2014-15.

In fact, there has been a stagnation in the transfer of non-Plan grants to the State governments in the past decade even during periods of high growth. As per the estimates by the Centre for Budget Governance and Accountability (CBGA), the non-Plan grants as a percentage of the gross domestic product (GDP) has ranged between 0.6 per cent and 0.9 per cent.

This issue has been a political hot potato for some time now, with a number of State governments, including those ruled by the BJP, demanding a fair share of the tax revenue. Earlier this year, Bihar Chief Minister Nitish Kumar asked the Finance Commission to recommend a 50:50 sharing of the Central tax revenue between the Centre and the States. In October last year, the Gujarat government made a similar demand to the Finance Commission. Jharkhand, Kerala, Bihar and Rajasthan too have sought a larger share of the Central pool of taxes.

A CBGA background note titled “14th Finance Commission: Issues and Challenges” states, “It is important to note that rising tendencies of centralisation, criticised widely among progressive sections in the policy circle, have not been restricted only to transfers made by the Planning Commission. In the last decade, the transfers by the Finance Commission have also shown that the ratio between non-Plan grants and Plan grants has declined substantially.” The paper further observes that the decline in the non-Plan grants to the States have imposed restrictions on the expenditure decisions of the States. Subrat Das of the CBGA said: “In the last 12 to 14 years, the States have been reluctant to increase their non-Plan expenditure, resulting in a freeze on the recruitment of regular cadre for public services in some States. In the realm of education and health, non-Plan spending by the States is often vital to carry out developmental activities.”

States’ concerns

The memoranda submitted by the State governments raise some common concerns about the way in which the States’ share of the Central revenue is determined. They argue that the revenue earned from the sale of telecom spectrum, along with other such revenues that are considered in the exclusive domain of the Centre, should be shared between the Centre and the States. Interestingly, the 13th Finance Commission had recommended that the proceeds from the sale of spectrum should be made a part of the divisible pool of Central tax revenues through a constitutional amendment.

The States have also asked for raising their share of Central revenues to 50 per cent. They have demanded that the 14th Finance Commission include the revenues earned by the Central government in the form of cesses and surcharges in the divisible pool of the Central tax revenue. Successive governments at the Centre have been routinely resorting to the levying of cesses and surcharges to keep the revenues outside the divisible pool of Central taxes.

The Rajasthan government’s memorandum highlights the unfair distribution of tax proceeds and the undue “expropriation of expenditure domain of the States by the government in various forms of Central Plan schemes inappropriate and uncalled for mandating of expenditures on the States under various Central legislations and schemes”.

It states that the increasing number of Centrally sponsored schemes and other variants have significant expenditure implications for the States in terms of cost sharing, providing supporting infrastructure, and committed liability. It States that in the case of the Sarva Shiksha Abhiyan (SSA), the matching contribution of the States has gone up from 15 per cent to 40 per cent and it is proposed to further increase the contribution of the States to 50 per cent. Also, the responsibility of maintaining the services and assets created under the Centrally sponsored schemes rests with the States. The memorandum also states that the increased burden of pay and allowances and pension liability of the State government as a result of the implementation of the Seventh Pay Commission recommendations will warrant greater transfer of tax revenue from the Centre to the States. It requests the 14th Finance Commission to raise the State’s share in Central taxes from 32 per cent to 50 per cent.

The Kerala government has highlighted the specific difficulties faced as a result of the growing need for non-Plan revenue expenditure without adequate growth of the Central tax revenue. Its memorandum states that the non-Plan revenue expenditure has grown owing to three major factors: interest payments, salaries and pensions. It further states that interest payments and pensions are difficult to bring down in the short term. The interest payments are increasing owing to the debt stream of the State and pension owing to the trajectory of the number of retirements and the longevity of the population.

Revenue expenditure is said to account for the major chunk of the State’s expenditure—its share in the total expenditure being in the range of 89 per cent to 91 per cent during 2007-08 to 2011-12. The expenditure on interest and pension payments for the same period accounted for almost 40 per cent of the total. The State government’s expenditure on social and education sectors has been rising consistently over a period of time. Interest payments are projected to increase by 58 per cent and salary by 80 per cent during the Twelfth Plan period (2012-13 to 2016-17).

Jharkhand has also demanded that the Centrally sponsored schemes be reduced to the minimum and the money released from the elimination of the schemes be transferred directly to the States. As per its submission, the expenditure on salaries, pensions and interest payments put together accounted for 52 per cent of the State’s total revenue expenditure in 2011-12, a substantial increase over the 35.3 per cent in 2009-10. The main reason was the increase in salaries on account of the recommendations of the Sixth Pay Commission. As a result, the State government adopted an expenditure management policy by containing the committed component of non-Plan revenue expenditure such as salary and wages, interest payments and pension payments.

The Bihar government’s memorandum states that although there has been a significant increase in the revenue surplus of Bihar since 2005-06, it was primarily the result of a reduction in its non-Plan revenue expenditure, to meet the Fiscal Responsibility and Budget Management (FRBM) Act targets on the one hand and to provide resources for capital outlay under the State Plans on the other. This has left limited room for the critical non-Plan components of development such as education, health, maintenance of roads and buildings, and irrigation and flood-control assets. This assumes larger significance given the fact that the 13th Finance Commission had discontinued the health grant without a good rationale. Further, the 13th Finance Commission had reduced the education grants for Bihar from 27 per cent to 17 per cent of the total education grant.

The constitutional mandate of the Finance Commission is to ensure that there is fair and equitable sharing of the Central tax revenue in a polity where the Centre has more sources of mobilising revenue, whereas the States have a large number of expenditure commitments and fewer sources of raising revenue. The sharing of resources is a mechanism of strengthening the federal polity and granting greater autonomy to the States to carry out developmental activities. The BJP-ruled States have persistently raised the demand for an increase in greater devolution of the tax revenue in the last two decades of the United Progressive Alliance (UPA) government.

It remains to be seen if the National Democratic Alliance government will facilitate greater useful expenditure on developmental activities by the States, an agenda which the BJP and its allies have persistently highlighted.