non-BJP states

Behind Union Govt’s Rhetoric of Higher Tax Devolution for States Lies a Silent Fiscal Crisis

The Union government announced that it disbursed Rs 1,18,280 crore as the third instalment of tax devolution to state governments in June, as against the normal of Rs 59,140 crore. But monthly figures often give misleading signals.

In a recent tweet, the Ministry of Finance announced that the Union government disbursed Rs 1,18,280 crore as the third instalment of tax devolution to state governments in June, as against the normal monthly devolution of Rs 59,140 crore. Monthly figures of Centre-state disbursements may often give misleading signals. In recent years, the fiscal capacity, and discretion of the Union government in collecting and disbursing promised tax revenue to states has remained more volatile.

The research team at InfoSphere, Centre for New Economics Studies (CNES), O.P. Jindal Global University, recently completed a study observing the Centre-state fiscal relationship more closely. A more detailed version of our findings was earlier discussed here. The factsheet shared by the finance ministry triggered a parallel deep-dive by the team investigating the available data (from 2019 onwards) on tax devolution-share of funds from the Union government to all state governments, drawn from government sources.

Some observations follow.

Figure 1. Source: Author’s calculations (InfoSphere, CNES)

Figure 1 presents the overall net tax devolution proceeds (in Rs crore) from 2019 onwards transferred by the Union government to all state governments. UTs are excluded from this list.

Figure 2. Source: Author’s calculations (InfoSphere, CNES)

Figure 2 (above) gives a macro-trend of tax devolution from the Union government on a year-to-year basis. This is a function of the accrued fiscal revenue capacity of the Union government over the last few years. FY 2020-21, the first year of the COVID-19 pandemic, was tough for the fiscal purse of the government as a whole and as a result, saw the lowest tax devolution level from the Centre to the states.

This forced states to borrow extensively to cover healthcare and other pandemic-induced costs from these ‘borrowed resources’. As a result, their fiscal deficit-debt levels rose. As argued earlier, there has been increasing evidence of the Union government arbitrarily squeezing the borrowing power of certain states, currently governed by opposition parties. Most state finance ministers have put this on record.

Figures 3 and 4 below provide a ‘select’ look at the Centre to State tax devolution levels for a few opposition-governed vs BJP-governed states (refer here for source).

Figure 3. Source: Author’s calculations (InfoSphere, CNES)

Figure 4. Source: Author’s calculations (InfoSphere, CNES)

States like Bihar and Uttar Pradesh still get most of the tax-devolution share from the Union government – largely because of their spatial, demographic, and socio-economic needs.

While states like Haryana, Punjab, and Kerala haven’t seen any critical growth in their tax-devolution share over the last five years. It is pertinent to note how each of these states has also seen its worst fiscal position scenario – accompanied by a decline in GSDP levels over these years too (worsening since the pandemic), which warranted a more interventionist, counter-cyclical fiscal support from the Union government.

Also, states like Tamil Nadu, Chhattisgarh, Himachal Pradesh, and Uttarakhand, haven’t seen any drastic shift in their net-devolution share too. This is despite states like Tamil Nadu, which have a strong GSDP position, contributing a lot more to the Union government’s tax revenue share.

A lack of vision in the medium to long-term fiscal-policy approach, from the Union government’s tax-based disbursements has therefore inadequately addressed this challenge/question: What role has the Union government, which, by law and constitutional power, is assigned more fiscal capacity and discretion to raise and spend tax-based revenue resources, played in supporting states through spending?

What we see in these trends are three broader, consequential categorical imperatives:

the Union government has merely maintained status-quo when it comes to giving states ‘what they need’. It hasn’t transferred more or envisioned to transfer more tax revenue with the aim to enable a given state’s own welfare or growth needs/revenue requirements. The available data on transfers for both BJP-governed and non-BJP-governed states tell a tragic tale of lopsided growth patterns evident across states, which is more of a continuum from the past, than seeing/realising change. This raises a more troubling question (for point 2).
what this says is the Union government under the Modi administration (since the last few years, read 2019 onwards from our data) has increasingly seen a gradual erosion in its fiscal capacity and will to support states which need more revenue for growth and welfare requirements. This fact subsequently has little to do with the political parties governing the states, but over time, the larger issue has become more aligned with the Union government’s own poor revenue collection capacity (i.e. failing to collect the revenue that the Union government projects in its own Union Budget estimate).
poor quality government data makes it extremely difficult for anyone to effectively analyse the potential gains/losses being made from the allocated tax devolution proceeds shared by the Union government for states over the last few years. See the RBI Handbook of Statistics for data on GSDP (2008-09 is the last year mentioned), or for poverty. The current administration, it seems, has done everything in its power to not even collect ‘good’ data which can help recognise fiscal challenges/potentials, to strengthen policy for the long-term good.

This is a marked sign of a fiscally weak and insecure government that is content to project empty riddles of economic optimism built merely around rhetorical hope, pasting ‘India Shining’ data on relative comparisons of good growth performance (made with countries industrially far more advanced and at a higher order of development), but underneath its own core, India suffers from a silent fiscal crisis and under poor macroeconomic fundamentals. These indicate an economy moving towards a state of permanent decline, sourced from structural weakness, in which any Union government will be able to do (fiscally) very little for states even if they want to do more (assuming there is a willingness to do so).

This article reflects the extensive research work, and statistical inputs offered by InfoSphere Team at CNES, O.P. Jindal Global University. To review InfoSphere’s work, please see its website here.

Deepanshu Mohan is an associate professor of economics and director at the Centre for New Economics Studies at Jindal School of Liberal Arts and Humanities, OP Jindal Global.

Mamata Extends Support to Delhi CM in Opposing Central Bill Giving More Power to L-G

Terming the move as ‘surgical strike’ on India’s federal structure, Mamata said she will write to all non-BJP CMs and political parties opposing the BJP to seek their support over the issue.

New Delhi: Terming a Bill brought by the Centre to give overarching powers to the lieutenant governor a “surgical strike” on India’s federal structure, West Bengal chief minister Mamata Banerjee has written to her Delhi counterpart Arvind Kejriwal extending her support in opposing it.

In her letter to Kejriwal on Wednesday, Banerjee, who is also the Trinamool Congress chief, said she will write to all non-BJP chief ministers and political parties opposing the saffron party to seek their support for him over the issue.

The Government of National Capital Territory of Delhi (Amendment) Bill, 2021, was introduced in Lok Sabha by Union Minister of State for Home G. Kishan Reddy on Monday.

According to the Bill, the “government” in the city would mean the “lieutenant governor” in the context of any law made by the legislative assembly. The Bill also makes it mandatory for the Delhi government to take the opinion of the L-G before any executive action.

Saying that since Prime Minister Narendra Modi and home minister Amit Shah have not been able to accept the defeat at the hands of the Aam Aadmi Party in Delhi assembly elections, Banerjee said the BJP now wants to strip away the legitimate powers of the chief minister and run Delhi by proxy.

Banerjee alleged that the Bill makes a “mockery” of the letter and spirit of democracy by disempowering the Delhi government, which is elected by the people of the national capital.

Also read: Centre’s Attempt To Give More Powers To Delhi L-G May Face Constitutional Challenges

She also pointed out that the Bill was in violation of the verdict by a five-judge Supreme Court bench in 2018, which “upheld the pre-eminence of Delhi’s elected government in all matters other than police, public order and land”. The then Chief Justice Dipak Misra had ruled that the lieutenant governor does not have independent decision-making powers and the real power must lie with the elected government.

(L-R) Delhi L-G Anil Baijal, home minister Amit Shah and Delhi CM Arvind Kejriwal at a meeting in New Delhi. Photo: PTI

“A balanced federal structure mandates that the union does not usurp all powers and the states enjoy freedom without any unsolicited interference from the centre,” the apex court had said in its ruling. He had added that the governor must work harmoniously with the Delhi government.

Also read: The Delhi Amendment Bill Will Increase Rift Between Elected Government and Centre

Mamata, in her letter to Kejriwal, said it’s “time for a united and effective fight against the BJP’s attacks on democracy and the Constitution, especially with regard to its plans to dilute the powers of state governments and downgrade them to mere municipalities”.

“The Government of National Capital Territory of Delhi (Amendment) Bill, 2021, which the BJP government at the Centre has introduced in the Lok Sabha, is a surgical strike on the federal structure of the Indian Republic as enshrined in the Constitution,” Banerjee said.

She added that but for her commitments in the ongoing campaign for the assembly elections in Bengal, she would have personally come to Delhi to express her support and solidarity with Kejriwal.

“I wish you success in your struggle. Your struggle is my struggle,” she said.

The TMC chief also said that what the saffron party was trying to do in Delhi has been done in states that are governed by non-BJP parties. “In state after state governed by non-BJP parties, the Centre has been creating problems for the duly elected governments by misusing the office of the governors,” she said.

“In many states, including in West Bengal, governors have been functioning like BJP’s office bearers and not as neutral constitutional authorities,” Banerjee alleged.

A Challenge to the 15th Finance Commission’s Credibility

The Additional Terms of Reference were issued at the fag end, when the commission had presumably completed all required processes.

On July 29, the president of India issued an order extending the date of submission of the report of the 15th Finance Commission (FC) to November 30, 2019. The same order also includes one additional term of reference (AToR). The commission is required “to examine whether a separate mechanism for funding of defence and internal security ought to be set up and if so, how such a mechanism could be operationalised”.

Incidentally, consultative process and close examination of finances of both the levels of government provide the foundation of a finance commission’s recommendations. This is what has contributed to its high credibility and its image as an independent and non-partisan institution. The AToR is issued at the fag end when the commission has presumably completed all the above processes.

The ToR of an FC is constitutionally defined under Article 280: Distribution of the net proceeds of the sharable taxes between the union and the states and allocation among the states; the principles that should govern grants in aid of revenues of the states out of the Consolidated Fund of India and later the 73rd and 74the amendment of the Constitution added the measures needed to augment the consolidated fund of a state to supplement the resources of the panchayats and municipalities on the basis of the recommendations of state FCs. However, under 280 (d) the President may refer any other matter in the interests of sound finance.

Beginning from the first FC, additional issues were in fact referred to successive FCs. These reflected one or the other concerns relating to sound budget and fiscal management. The AToR which relates to protecting defence and internal security expenditures of the Union government does not fit in the framework of the constitutional provision, Article 280 (d).

Similarly, defence is in the Union list and therefore the responsibility of the Union government while internal security is largely the states’. Even when states requisition para military forces, they bear the expenses. It is not, therefore, an issue that should legitimately come under the domain of the FC.

Also read: The 15th Finance Commission May Split Open Demographic Fault Lines Between South and North India

In any case, the original ToR itself incorporates a consideration to have regards to, “The demand on the resources of the central government particularly on account of defence, internal security, infrastructure, railways, climate change, commitments towards administration of UTs without legislature and other committed expenditure and liabilities.”

There could be two reasons why this AToR is added at this stage. One, the defence expenditure declined from 2% of GDP in 2014-15 to 1.48% in 2018-19 and even lower at 1.45 % in 2019 -20 budget. Similarly, defence expenditure as a percentage of the government’s expenditure declined from 14.3% in 14-15 to 11% in 20i9-20. The other is that with the slowdown of the economy, it would be a challenge to even ensure this low level of allocation provided in the budget for 2019-20 while maintaining the fiscal deficit at 3.3%. Hence, the attempt to ring-fence the defence expenditure.

Having been referred to, what could the 15th FC do?

As noted earlier, the FC is already required to, under the original terms of reference, take into consideration the defence and internal security needs. While assessing the requirements of the Union government, the 15th FC should explicitly take into consideration the fact of the declining defence expenditure as a percentage of its total expenditure and make appropriate provisions in its expenditure projection.

The 15th FC could also recommend that the Union government reallocate expenditures wherever possible and eliminate wasteful expenditure. Further, it could suggest that the government mobilise more resources from sources such as the following: first, it should take measures to raise the tax-GDP ratio which has slumped to 11.7% in 2019-20 (Budget Estimates) as compared to 11.9% in the Revised Estimates to augment its resources to meet its expenditure requirements.

Second, it could minimise undisputed tax arrears which stood at around nine lakh crore at the end of 2017-18 and non-tax arrears of about 2 lakh crore in the same year. Similarly, the government could rationalise the tax incentives given to the corporate and non-corporate sectors – for the corporate sector alone, it was estimated at 1.39 lakh crore in 2018-19, which perhaps would decline following the recent policy decision if the corporate sector avails the lower rate of corporation tax, by giving up the incentives and exemptions they have been enjoying. Third, the Union government could monetise the huge chunk of government land under the ministry of defence, the railways etc., which the thirteenth commission, indeed, had recommended.

Also read: On Finance Commission Allocations, Modi Is So Far off the Mark, It Isn’t Even Funny

What should the 15th FC not be doing?

Over the years, the FC has established itself as a non-partisan institution of fairness and neutrality in which states repose a great deal of trust. It should not do anything that has an adverse impact on the divisible pool. In any case, the divisible pool is under significant stress. First, the 15th FC may not be able to increase states’ share beyond 42% that the 14th FC recommended.

Second, with a slowdown of the economy, the divisible pool would be adversely impacted. Third, with seven state taxes being subsumed in the GST, the states’ ability to mobilise resources from their own sources has been constrained. Fourth, the GST has yet to emerge as a buoyant tax.

On the contrary, CAG (Report no. 11 of 2019) noted that its yields declined by Rs one lakh crore in the revised budget of 2018-19 as compared to the original budget for 2018-19. It might further decline until the slowdown of the economy is reversed. States’ GST revenue with 14 % growth would be protected till 2022-13 but not for the entire award period of the 15th FC.

Fifth, cess and surcharges that are outside the divisible pool have increasingly become important instruments of revenue mobilisation. Just to illustrate, while the total transfer to states and UTs were Rs 4.1 lakh crore in 2017-18, revenue mobilisation by the central government through cess and surcharge stood at 3 lakh crore or 15.7 % of Centre’s gross tax revenue.

This went up to 5.12 lakh crore in 2019-20 (BE) accounting for 21.03% of the Centre’s gross revenue as against the total transfer to states and UTs to only 5.2 lakh crore in 2019-20 (BE). Last but not the least, even after rationalisation and restructuring of the centrally sponsored schemes, there remain 28 core schemes in which the general category states are required to contribute in 40% for their costs and three optional schemes requiring states to contribute 50%. Increasing states’ contribution to Core and optional schemes has clearly led to reducing states’ fiscal space and autonomy.

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

For all these reasons, the 15th FC should deal with the AToR in a way that would have no adverse impact on the divisible pool which is already under great stress.

Atul Sarma is the chairman of the OKD Institute for Social Change and Development and was a member of the 13th Finance Commission.

Will the 15th Finance Commission Give Delhi its Due on Central Taxes?

If the Centre can include Puducherry as a constituent of the FC-XV, why should Delhi not be treated similarly?

On May 17, finance ministers of five non-BJP states met President Ram Nath Kovind to discuss the terms of reference for the Fifteenth Finance Commission (FC-XV). They submitted a memorandum suggesting several amendments to the terms provided to the commission by the president earlier this year.

The finance commission is a constitutional body set up by the president every five years to determine the share of each state in central taxes. A large portion of this pool of funds is set aside for the use of the Central government, and the rest is distributed to the states.

The meeting with the president was a culmination of weeks of deliberations between the finance ministers of non-Bharatiya Janata Party (BJP) states since April. Initially, the debate was dominated by the fact that the use of the 2011 Census instead of the 1971 Census puts southern states at a serious disadvantage. But many other concerns have come up through these deliberations. The last point on the list of suggested amendments submitted to the president was specifically about Puducherry and Delhi, both of which are Union territories (UTs) with legislature.

It was suggested that a “suitable amendment be made in the TOR (terms of reference) to ensure that the award of Fifteenth Finance Commission must apply to UTs with legislature also.”

In the past, the terms have specified that the commission should consider the demands on resources of the Centre as well as states in the process of carrying out their respective functions. Union territories have not found any mention in these documents, because they were possibly considered an implied burden on the Centre. However, Delhi and Puducherry, both of which are UTs with legislature, have never been considered by any Finance Commission while determining the share in central taxes. In October last year, the Centre decided to treat Puducherry “at par with states” for the purpose of devolution of funds, but not Delhi.

Delhi chief minister Arvind Kejriwal with his deputy and finance minister Manish Sisodia. Credit: PTI

Delhi chief minister Arvind Kejriwal and his deputy and finance minister Manish Sisodia point out that Delhi pays as much as Rs 1.08 lakh crore or 13% of India’s entire direct tax collection. Credit: PTI Files

In fact, the terms of reference for FC-XV went one step further to exclude Delhi. Clause 3 of the terms have the following sub-clauses:

(ii) The demand on the resources of the Central Government particularly on account of defence, internal security, infrastructure, railways, climate change, commitments towards administration of UTs without legislature, and other committed expenditure and liabilities;

(iii) The demand on the resources of the State Governments, particularly on account of financing socioeconomic development and critical infrastructure, assets maintenance expenditure, balanced regional development and impact of the debt and liabilities of their public utilities;

On the one hand, sub-clause (ii) states that the commission shall consider the financial burden of administering UTs without legislature (Chandigarh, Lakshadweep, etc.), and on the other, sub-clause (iii) which deals with state governments, makes no mention of UTs with legislature.

What makes Delhi’s conundrum more pronounced is the manner in which the finance commission determines the distribution of funds to states for supporting local bodies. Chapter 9 of the FC-XIV report reveals that the commission used the State Finance Commission (SFC) reports to recommend the distribution of Rs 87,143 crore for urban local bodies. SFCs, like the Central Finance Commission, are also constitutionally mandated. Delhi has constituted its fifth SFC, but has been unable to fully implement the recommendations of the fourth SFC.

Despite Delhi being a UT with legislature, for the purpose of devolution of funds to its municipal bodies, it is considered a state. But when it comes to receiving its fair share of central taxes to foot the bill of the SFC’s recommendations, Delhi is neither a state nor a UT.

If the Centre can include Puducherry as a constituent of the FC-XV, why should Delhi not be treated similarly?

There needs to be a much larger legislative intervention to improve Delhi’s status. With the ongoing dispute between the Centre and Delhi government in the Supreme Court over the extent of powers enjoyed by the latter under the current constitutional scheme, it is unlikely that this BJP government may be keen on such interventions. However, there is one area where the two governments can reach common ground.

When the constitution was amended to introduce the Goods and Services Tax (GST), Article 246A clarified that the word ‘state’ would include ‘UTs with legislature’, for the purpose of that Article. A similar amendment can be made for all the articles that apply to the provisions in the constitution for distribution of taxes. If such an amendment is made, Delhi will have to be included in the award of the FC-XV. This will help the ruling BJP as well, since Delhi will have enough funds to implement the recommendations of the SFC, and BJP-ruled municipal bodies will benefit the most.

Central Bureau of Direct Taxes data shows Delhi pays as much as Rs 1.08 lakh crore or 13% of India’s entire direct tax collection and receives Rs 325 crore each year from the Centre. Contrary to perception, Delhi’s government does not run on central funds, despite being the capital city. In fact, Delhi contributes a disproportionate amount as central taxes that are actually used by other states.

There is obviously nothing wrong with Delhi’s tax money being used in other states, but isn’t it time Delhi gets its due?

Akshay Marathe is National Joint Secretary, Aam Aadmi Party. He works with the Delhi government on education policy.