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.

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 14^th 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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Also read:

• Nilakantan R.S. on why the 15th Finance Commission may split open demographic fault lines between South and North India

• How the 14th Finance Commission punished Tamil Nadu

• Subnationalism: the key to social development in India?

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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.

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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.