Finance Commission must reset the balance

POLITY/ GOVERNANCE

Topic: General Studies 2:

• Responsibilities of various Constitutional Bodies. 
• Devolution of powers and finances up to local levels and challenges therein. 

Finance Commission must reset the balance

Context: The COVID-19 has deepened the faultlines in Centre-state fiscal relations. Against this backdrop, the 15th Finance Commission is expected to submit its report by October 2020

The Commission’s report will be critical on two counts: 

• First, it will determine how India’s fiscal architecture is reshaped
• Second, how Centre-state relations are reset as the country attempts to recover from the COVID-19 shock

Challenges ahead for 15th FC

• Dominance of Centre: The present dispensation is at unease with extending greater fiscal autonomy to states. This was apparent in the framing of the terms of reference of the 15th FC. Centralisation of political power may well lead to demands for centralisation of resources. 
• Issue of tax devolution to states: 42% of Central divisible pool of resources were allotted to States on recommendation of 14th FC. There is pressure by Centre to get back the fiscal space it ceded to the states and assert its dominance over the country’s fiscal architecture
• States Vs Centre: Challenge for 15th FC to balance the contesting claims of Centre (reduced devolution and conditional funds) and the states (more untied funds)
• Containing Debt-to-GDP ratio: FRBM review committee had envisaged bringing down general government debt to 60% of GDP by 2022. However,the debt-to-GDP ratio may well be over 80% this year which 15FC has to factor in.
• Sharing of debt reduction: In the wake of increase in Debt-to-GDP ratio, 15th FC will have to lay out a new fiscal path to be followed by both Centre and states. There is challenge of ensuring the burden of debt reduction fall equally upon the Centre and states
• Leeway for Centre: The Commission may allow the Centre to have greater leeway when it comes to fiscal consolidation as the fiscal multiplier of central government capital spending is greater than that by the states
• Issue of state borrowings: Recently, the Centre increased the State’s borrowing limits, linking it with reforms. There is challenge that FC, in line with its terms of reference, go along with the Centre’s stance and recommend imposing conditions on additional borrowing of states and formalise this arrangement
• Issue of the GST compensation cess: The GST council is yet to give its views on the extension of the compensation cess to offset states losses beyond the five-year period. 15th FC has to consider this too. It may argue in favour of extending the compensation period, as states desire, but, perhaps, lowering the assured 14% growth in compensation and linking it to nominal GDP growth

Need to relook at the Centre’s expenditure priorities

• Over the past decades, there has been a substantial increase in the Centre’s spending on items on the state and concurrent list
• This shift has occurred even as grants by the Centre to states exceed the former’s revenue deficit. This, as some have pointed out, effectively means that the Centre is borrowing to transfer to states.
• Additionally, any attempt to shift the uneasy balance in favour of the Centre will dilute the government’s agenda of Cooperative Federalism and reinforces its centralising tendencies
• Thus, there is a need to review some of the Centre’s own spending programme.

Way Ahead

• The fiscal stress at various levels of the government necessitates a realistic assessment of the country’s macro-economic situation
• There is a need to prepare medium-term fiscal roadmap, as well as careful calibration of the framework that governs Centre-state relations.
• 15th FC could request for another year’s extension to present its full five-year report citing the prevailing uncertainty.

Connecting the dots:

• 15th Finance Commission’s interim report- Click here
• N.K. Singh panel on review of FRBM Act.