‘Population skew’ in resources to be balanced out by 15th FC
The Hindustan Times, November 07, 2020
The NK Singh-led 15th Finance Commission (FFC), which decides the sharing of resources between the Centre and states, has devised a formula to “balance out” a potential loss in the financial share of southern states because they had better demographic outcomes and lower population, an official with knowledge of the matter said on condition of anonymity.
The FFC is set to submit its final report to President Ram Nath Kovind on November 9. It is unlikely to be made public immediately and will likely be tabled in Parliament when the budget is presented next year.
To decide a state’s share in taxes and revenues, finance commissions usually rely on parameters such as income distance, population size, geographical location and forest cover, etc, which are then assigned weights.
Income distance is the difference between the per capita income of a state and the average per capita incomes of all states. Poorer states, usually with high population burden, for instance, may get a higher share in resources.
Many southern states, such as Kerala, Tamil Nadu and Andhra Pradesh, were unhappy with the terms of reference of the FFC because the body was mandated to take into account the 2011 census, instead of the 1971 census, as the basis for population. This, some southern states argued, would lower their share and penalise them for keeping population growth stable, creating a huge controversy.
“The issue before the commission was therefore what’s the balancing (that is required), looking at the terms of reference,” the official cited above said, that would ensure that states that did well in terms of controlling their population under control.
Simply put, this means the commission has devised a formula that will adjust the potential loss in financial share of southern states.
The FFC was constituted in Nov 2017 to recommend transfer of resources for the 2020-25 period. It had to submit two reports. The first, recommendations for the financial year 2020-21, was an interim report tabled in Parliament on February 1, 2020. In its 2020-21 report, the FFC assigned 15% weight to the population of a state, down from the 17.5% allocated by the 14th FC, but raised the weight under demographic performance from 10% to 12.5%.
“The commission reserves the right to amend any or all the parts of the 2020-21 report, depending on the situation. The 2020-21 report was written in the pre-pandemic era, while the final report was written in the post-pandemic period,” the official said, declining to reveal the devolution formula.
The Constitution, through Article 280 to 281, provides for finance commissions, set up every five years, as a mechanism for division of taxes and revenues vertically i.e. between the Centre and states, and horizontally, i.e. among all states, based on their levels of development, prosperity and regional needs.
A key proposal by the Centre to the FFC was the creation of a non-lapsable defence and internal security fund either through allocation from the divisible pool of funds shared by the Centre and states or through a cess.
“There were very conflicting views on that issue, not everybody is on the same page,” the official said. “Whether to have, or not have it (defence fund), the nature of financing, will it be by way of an additional taxation proposal… the most obvious one is a cess, and then cess has other implications,” the official added.
The pandemic has posed a huge challenge for the FFC, the official said, because the “base of resources is shrinking”. The economic damage caused by the pandemic has resulted in inflation-adjusted gross domestic product (GDP) shrinking 23.9% in the June quarter.
According to the finance ministry’s estimates, economic growth without adjusting for inflation, called nominal GDP, is likely to grow 19% in the next fiscal (2021-22). Nominal GDP growth has a great bearing on the FFC’s recommendations as it determines tax collections.
The official said given the “shrinking base”, what states would get in absolute terms would matter more than the percentage share. Also, since the pie is smaller, the grants component recommended by the FFC “becomes very important for states”.
“The approach on the grants component, which are percentage amounts, is to lend a degree of sustainability, predictability and reduces volatility (in states’ finances),” the official said.
All finance commissions in the past have increased the share of the states incrementally and not reduced it.
The 14th FC, in a quantum leap, increased the share of states by 10 percentage points to 42%. Experts believe that regardless of the pandemic, the FFC’s recommendation will provide continuity, instead of a radical departure, as far as devolution to states is concerned.
“In my opinion, the pandemic should not impact the devolution formula mainly because all states have been affected equally. What might be impacted is the fiscal responsibility and budget management roadmap because the pandemic has put huge pressure on both expenditure and revenue,” said NR Bhanumurthy, vice-chancellor of the Dr BR Ambedkar School of Economics, who did a study for the FFC.
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