In the Garb of Promoting Federalism Has the Centre Diluted Its Duty to National Priorities?

A rethink of the role of the centre to go beyond current effort of tinkering with financing instruments and return to first principles can determine an optimal allocation of functions across all levels of government within a federal structure.

Finance Minister Arun Jaitely’s 2015 Budget raised several concerns about the future of social sector investments in the country. The Budget mandated large scale cuts in social sector funding: central assistance to states – the primary instrument through which the union government finances social sector investments – was cut by 39% compared with the 2014-15 planned Budget (or Budget estimates), or 26% if we compare the 2015-16 allocations with actual monies transferred by the center (or revised estimates) in 2014-15. Total funding for Centrally Sponsored schemes (CSS) was reduced from 2.52 lakh crore rupees (BE) to around 1.69 lakh crore rupees in 2015.

From the government of India’s (GoI) perspective, these cuts were a necessary consequence of the recommendations of the Fourteenth Finance Commission (FFC), accepted by the GoI in February 2015. In a bid to re-haul center-state fiscal relations and reduce central interference, the FFC sought to enhance the states’ share of no strings attached, untied central tax revenue from 32% to 42%. With the money devolved to states it was now up to the states to invest in social programs as they saw fit.

As a long-standing votary of greater devolution to states, for this columnist, the FFC was a great opportunity to redress inefficiencies caused by excessive centralisation in social sector programs. However, the transition, as envisaged in the last Budget, did raise important concerns. Days after the Budget was announced, state governments began to argue that any potential gains from enhanced devolution were likely to be offset by cuts in plan schemes. Added to this, the government entrusted the Niti Ayog to undertake a long overdue re-structuring of CSS. Consequently, it was only as late as October that the GoI line ministries and state governments received information on the quantum of money they were expected to allocate to these schemes.

Amidst this chaos, the move to empower state governments and the consequent rationalising of plan funds also raised several questions about the role of the centre in social sector financing: does more money to states necessarily translate to greater and more efficient investments in social sectors? And is it appropriate for the center to divest itself of responsibility for what are key national priorities?

While these questions were asked and debated repeatedly through much of the year, there is relatively little by way of data or analysis on what actually happened on the ground. Part of the reason for this was the complete lack of preparedness. States seemed to have been caught completely by surprise – many having passed their 2015-16 budgets in advance of the recommendations being accepted. Others made some quick changes to their budgets in the expectation that the real picture would be revealed later in the year when state legislatures passed the supplementary budgets. For the most part, only a handful of states have placed their supplementary  budgets in the public domain. Thus, a national picture will only be revealed once the states make their 2016 budget documents public. Added to this, state budgets are notorious for their opacity.

Despite these constraints my colleagues Avani Kapur and Vikram Srinivas investigated the budgets of 13 states and arrived at some preliminary understanding of what is happening in those states – ranging from Bihar (a state heavily dependent on the GoI for finances) to fiscally stronger states like Maharashtra and Karnataka. Their findings help us answer at least some of the questions raised through the year.

First, do states have the fiscal space to invest in social sector programs? On balance, the answer is yes! If we compare 2014-15 (RE) with monies expected to reach states in 2015-16, most states with the exception of Telengana (-20%), Uttarakhand (-14%), Karnataka (-3%) and Maharasthra (-3%) received about the same or significantly more money from the center, despite cuts in CSS. It is important to note that both Karnataka and Maharashtra significantly enhanced their estimates of own revenue collections between 2014-15 and 2015-16, and are thus likely to make up for the loss in central funds with their own resources. Even Bihar, that made headlines for having got a poor deal in the FFC restructuring, has enough funds available to maintain social sector expenditure at the 2014-15 level. In a recent article in the Economic and Political Weekly, economist Pinaki Chakraborty estimates that even if Bihar were to use its available untied resources to fully finance central schemes that the GoI was no longer funding, the state would end up with a surplus of Rs. 4,300 crores. So the GoI is right when it argues that the action is now at the state level.

But this doesn’t mean that the centre and its CSS do not have a critical role to play in social sector financing, even as it currently stands. The centre continues to fund key schemes like the Sarva Shikshan Abhiyaan, Swacch Bharat Mission and the Mahatma Gandhi National Rural Employment Guarantee Program. While the exact numbers are difficult to ascertain, a quick back of the envelope calculation suggests that these schemes remain critical to the overall expenditure portfolio of states. In Rajasthan, for instance, nearly one-fourth of the social sector budget for 2015-16 is tied to these schemes. Thus, it is important to understand what the impact of cuts and re-structuring might have had on monies flowing from these schemes. Here are examples from two critical CSS:

Sarva Shiksha Abhiyan (SSA)

The SSA is the government’s primary instrument for financing the Right to Education. Thanks in part to the confusion over funding patterns, by September 2015, half way through the financial year, the GoI had released a mere 31% of the annual budget to state governments. To make up for these low releases, some states began dipping into their unspent balances. The SSA is notorious for low expenditures. In 2014-15, the country had underspent is SSA by 26%. But this money is fast drying up; by September 2015, states like Karnataka and Maharashtra had spent nearly all their SSA money (including unspent balances). On the other hand, the low releases also gave states an excuse not to spend! Bihar and Uttar Pradesh chose to hold back and had spent just about 40% of their funds available, compared with over 90% in 2014-15.

Chart 1: States’ expenditure on SSA

The effects of these slow releases were directly visible on the ground. Data from a 10-district fund tracking survey across Bihar, Himachal Pradesh, Madhya Pradesh, Maharashtra and Rajasthan conducted by Accountability Initiative in December 2015 highlights that a mere 50% schools had received their annual grants (amounting to approximately 1,5000 rupees), monies which schools use for essential supplies. Compare this with the previous year when more than 70% of these schools received these grants.

Integrated Child Development Scheme (ICDS)

The ICDS made headlines after the Budget for being the biggest victim of cuts – allocations were reduced by nearly 50% from 2014-15 in the 2015 Budget. The government made up for these cuts in the supplementary announced in December but the consequence of this bore heavily on the everyday functioning of the anganwadi centres. For instance, all anganwadi centres are expected to receive an annual grant (called a “flexi grant”) from the centre. A mere 41% of centres reported receiving this money, according the Accountability Initiative’s December survey. This number was a much higher 71% in 2014-15.

It is important to remember that these delays in money flows are not unique to this financial year. India’s fiscal system is infamous for its inefficiency and anyone familiar with the country’s public finance management systems will tell you that much of government expenditure takes place toward the end of March – to meet end of year financial targets. The chaos induced by the FFC transition and the CSS re-structuring simply exacerbated old problems. Addressing the inefficiencies in India’s fund flow architecture requires simple technocratic fixes but so far no government, across political parties, has demonstrated the will or interest in doing so.

It is likely, as governments get used to the new fiscal regime, that some of the chaos and confusion of 2015 will resolve itself. But the full import of the FFC on social sector financing will only be realised if the GoI now turns its attention to the tricky question of its own role in the new regime of centre-state relations.

It is important to preface this discussion with some evidence, as limited as it is. Thus far, the FFC devolution and cuts in CSS have not resulted in any real reduction in social sector expenditure at the state level. Rather, all states studied, with the exception of Bihar, increased their social sector investments.

Chart 2: Changes in Per Capita Social Sector Expenditure Post FFC

However, spending on social sectors as a proportion of total spending dropped by about 1% in 2014-15 for most states studied. Rajasthan was the exception, which increased spending by 3%. This initial analysis suggests that for the moment the states and the GoI have been able to maintain the status quo.

Going forward

But what does this mean going forward? To answer this question, it is important to understand the political economy of CSS financing. Over the last decade the GoI rapidly expanded its role in financing key social programs through one-size fit all, tightly designed CSS. Implementing these schemes required the centre to tightly control and monitor state budgets, thus casting GoI officials in the role of headmasters rapping states on their knuckles if they didn’t follow guidelines. While the states disliked the centralised approach, saw in CSS an important source of money that they aren’t happy to give up. This explains why almost every state politician and bureaucrat, having complained to the FFC about these schemes, is now crying hoarse about the lack of funds, paying scant attention to the more pressing question of how best to use the untied funds. But CSS also played an important role in ring fencing money for social programs at the state level. I am surprised at how many state level politicians and bureaucrats have argued with me about the importance of CSS in ensuring social sector investments because of the proclivity to invest money in big-ticket infrastructure programs where the kickbacks are higher. Given this, there is a risk in FFC recommendations ending up being more destructive than constructive for the social sector in the long run.

The answer cannot lie in going back to the old inefficient system of greater central intervention in financing. Rather, there needs to be a serious rethink of the role of the centre, one that goes beyond the current effort of tinkering with financing instruments and returns to first principles to determine what the optimal allocation of functions across all levels of government within a federal structure ought to look like. It also needs extensive discussion on ‘how’ to monitor and what kind of administrative design can ensure autonomy at the state level along with incentivising accountability for performance. If I have one ‘ask’ from this year’s Budget, it is not more allocations but some policy commitment to re-structuring the role of GoI line departments in social policy. Else the FFC will go down in India’s history as nothing more than a missed opportunity.

Yamini Aiyar is with Accountability Initiative, Centre for Policy Research.