Financial Aspects of Sarkaria Commission Report

It has recommended an amendment to the Constitution for enabling the Parliament to provide for the sharing of the corporate tax along with suitable adjustments in sharing income tax and excise duties between the Union and the States. It has also recommended the appointment of an expert body to recommend desirable directions of reforms in taxation and resources mobilization by the Centre and the States. But it has expressed itself against the transfer of more subjects to the States and pleaded for a strong Centre to preserve the unity and integrity of India. The Commission has, however, suggested that the Finance Commission which is appointed after every five years should be made a permanent body, and that the Planning Commission be made a constitutional body and provided with a Secretariat. Academicians like K.N. Kabra have suggested that ‘the practice of the Centre appointing the members of, the Planning Commission must be replaced by a system by which they are jointly appointed by the Centre and the States’.

In keeping with the recommendations of the Sarkaria Commission Report, the United Front Government in its common minimum programme aimed at restoring a balance in the economic equation between the Centre and the States and bestowing greater autonomy on the latter in order that they are enabled to determine their needs and priorities independently.

The regional parties have demanded greater devolution of fiscal powers to the States. It was in the name of the centralized planning that the Centre over the years had deprived the States of their rightful due from the fiscal resources. Beginning with 1991 there has been a major reorientation in economic ideology of the Indian aggregate State in favour of economic liberalization, so one would hope that consistent with this ideology the Centre would decentralize the planning process.

The Commission has juxtaposed the development of the last thirty-seven years into ‘two diametrically opposed trends’. On the one hand, there has been a centripetal force in the economy and, on the other, centrifugal forces in the polity ‘on account of break-up of the old political order. Some of the symptoms are: Split of national parties, ever-increasing exploitation of populist slogans and caste, language, money and muscle power in elections’.

The Report shows an overriding concern for ensuring the solemnity of the ‘arranged marriage’ between the parliamentary and federal systems. The marriage is sound, proclaims the Commission and it is worth preserving. And if there has been unevenness in its working, it is primarily because the parties have abused the code of conduct so necessary to its successful functioning.

The states can be given, suggests the Commission, greater powers and more revenue; such adjustments can be made through minor constitutional amendments, and they do not call for any major changes in the Constitution. But this is not the remedy to out malaise. The problem, reports the Commission, is that of role-disorientation of political actors, and the lack of institutional values governing political behaviour. Thus the advice of the Commission to the new breed of federalists and State autonomists is simple: ‘reform themselves.

The same approach is evident with regard some other controversial issues such as reservation of State bills by the Governor or Presidential considerations and deployment of paramilitary forces of the Union in States on public order duties. To promote inter-government consultation between the levels of government, the Commission has made two recommendations: the creation of a modified National Development Council renamed as National Economic and Development Council under the Constitution rather than an executive resolution, and the setting up of an Inter-Governmental Council under Article 263 of the Constitution. The latter body has since been constituted.

General Observations Made by the Commission

In India, because of the diversities in religion, language, caste, race, etc. there are a large number of groups, seeking to establish their identity and promote their sectional interests. The issue of devolution of powers and responsibilities between the top two tiers of government, Centre and states, needs, therefore, to be considered in the context of the broader issue of decentralisation between these and other tiers of government on the one hand, and the functional agencies within each of these tiers, on the other.

Part II of the Report discusses various memoranda and opinion received from the State governments, political parties, and other organisations. Several proposals are suggested for reforms. However, most of these proposals are rejected by the Commission. It is neither willing to compromise with the principle of parliamentary supremacy nor the unity of command in the Union Executive in the last recourse. The Commission has left the existing pattern of legislative, administrative, and financial relations between the Union and States by and large unaltered. The All-India Services, recruited and trained by the Union and allocated to the State cadres, are not tinkered with either, not withstanding the fact that these at least partly compromise the federal principle.

In fact, the Commission recommends that a few more services of this nature should be constituted in the national interest. The whole scheme of three kinds of emergencies, which is potentially unitary in its impact on the federal provisions of the Constitution, has also escaped unscathed. Although it has recommended a very limited measure of revision in the pattern of resource sharing between the Union and the States, it has proclaimed as sound the present pattern of division of roles between the Finance Commission (that advises on non-plan resource transfers) and the Planning Commission (that recommends plan resource transfers).

The entire machinery of government in States, including the government and Presidential rule, is found by the Commission to be in order. The pre eminent role of the Parliament in amending the Constitution is not faulted either. The Commission in all these matters sees the prospect of a consensus in the country, and pronounces that there may be some smoke out there but there is no fire. 

However, the Commission has endeavoured to expand the area and practice of consultation between the Union and the States and an evolution of sound conventions of institutional and political behaviour on the part of political elites. For instance while rejecting the demands for a major revision in legislative and taxation powers of the Union and States, the Commission recommends that the Union government should by a matter of convention hold prior consultation with the State governments or with the affected ones before it legislates in the area of inter-State trade and commerce and concurrent jurisdictions.

The Commission underlined the imperative of enlarging the institutional structures for consultation between the two levels of the government in pursuit of creating consensus as the basis of federal decision-making and action. To this end, the Commission recommended that the National Development Council be given a Constitutional status with a new name-National Economic Development Council. Similarly, for deliberations on political matters in Centre-State relations, it recommended the creation of the Inter­governmental Council (IGC) under Article 263 of the Constitution.

Besides, it has also proposed that the Planning Commission be reconstituted with a constitutional status and the Finance Commission appointed every five years under the constitution be made a permanent body. The Commission also took a strong critical view of the misuse of Article 356 relating to the President’s rule in States on the pretext of constitutional emergency and inordinate delays in Presidential assent to State legislations reserved by the Governor for review by the Centre.

The interests and aspirations of most people are concentrated in the localities in which they live and carry on their avocations of life. Normally, they would be content to compete at the level of the local governing bodies, making way for persons interested in larger issues of regional or national significance, to opt for higher elective forums. Decentralisation of real power to these local institutions would thus help defuse the threat of centrifugal forces, increase popular involvement all along the line, broaden the base of our democratic polity, promote administrative efficiency and improve the health and stability of inter-governmental relations.

The Constitution of India creates two tiers of government, one at the levels of the Centre (or Union) and the other at the level of the states. At the sub-state level also there are tiers, which are the creations of the state government. There are: gram Parishad and gram Panchayat. It is noteworthy that the Constitution casts a duty on the state to take steps to organise village panchayats and endow them with powers and authority to enable them to function as units of local government.

In this system, the district, in particular, holds a central position. The importance of developing adequate sub-state level political institutions cannot be overemphasized. It is only by providing opportunity that people can be trained to shoulder responsibilities in a system of local government. In 1959, a major experiment in decentralisation of power was launched based upon the findings of the Balwant Rai Mehta Committee on Panchayati Raj. Its success, however, has been limited.

There is considerable truth in the saying that undue centralisation leads to blood pressure at the Centre and anemia at the periphery. The inevitable result is morbidity and inefficiency. Indeed, centralisation does not solve but aggravate the problems of the people.

The Sarkaria Commission emphasised the need for decentralisation of the planning process. The objectives of decentralised planning cannot be achieved unless the Panchayati raj and other local bodies are allowed full scope to play their role.

The working of the Constitution since in its inception in 1950 has demonstrated that its fundamental scheme and provisions have withstood reasonably well the inevitable stresses and strains of the movement of a heterogeneous society towards its development goals. The Constitution has been amended a number of times to adjust its working to the changes in the environment.

‘In our view, the Commission observes, ‘it is neither advisable nor necessary to make drastic changes in the basic character of the Constitution’. But there is certainly scope for improvement and reform in a number of aspects.

The Constitutional amendments having bearing on Centre-State relations, suggested by the Sarkaria Commission, though significant, are not many. The functional aspect of Centre-State arrangements that it proposed is far more substantial. The Commission concluded on note of self-questioning.

Effective participation by citizens is an integral part of democracy. Large parts of the programmes, projects and services initiated by the Centre are executed in the states. Many of the programmes undertaken by the states also have wider implications for the centre as well as local governments. There is at present no forum where a citizen can present his view on all these matters. No doubt the inter­governmental council would discuss various issues of national importance. But it would necessarily be in camera.

So far none of these recommendations, except for the setting up of the IGC has been implemented. However, the change in the party system from one-party dominance to a multi-party system since 1989 has altered the context of Centre State relations.

This has resulted in a greater opening for consultation between the two levels of the government and a reduction in the incidence of partisan misuse of President’s rule in States. The full implementation of the Commission’s recommendations would lead to a quantum leap in the direction of the federalisation of the system by constituting a series of points of autonomy in federal relations and consultation.

The recommendations of the Sarkaria Commission were first perceived by the State autonomists to be rather conservative inasmuch as it mainly emphasised a change in attitude and behaviour of the political elites rather than any major constitutional amendments. However, when the report was placed on the table of the Parliament, the then opposition parties generally commented that even though they were not fully satisfied with the recommendations of the panel, they hope that the government would sincerely implement them in totality. By listing certain considerations which the Finance Commission might, inter alia, keep in view in recommending grants-inaid of revenue to the States, the Finance Commission has been 'shackled'. Some State Governments are of the view that the recommendations of the Finance Commission should be implemented in toto. The non-implementation of the final recommendations of the Eighth Finance Commission in full, has added yet another dimension to the problems in financial relations between the Union and the States.  Several State Governments have criticised the so-called 'gap-filling' approach of the Finance Commission in determining the quantum of Central transfers. 

Capital Transfers and Market Borrowings 

Several States have pointed out that their capital receipts are meagre in relation to their large and growing requirements of capital funds for investment in development activities. They are, it is argued, very heavily dependent on the discretion of the Union for their capital receipts. A suggestion has been made by some that the States should have access to the capital resources "as a matter of right". 

Among the important sources of funds for development are market borrowings and capital transfers from the Union. Of the total market borrowings of the Union and the States, the share of the States has declined over the years. Further, as a proportion of the total capital receipts of the Union, loans to the States have also gone down.

The limitations imposed on the States in this regard under Article 293 are also objected to by many State Governments as restricting their freedom to borrow. 

Bond Floatation by Central undertakings 

Bond floatation allowed to some of the undertakings of the Union Government (e.g., National Thermal Power Corporation, National Hydro-Electric Power Corporation and Indian Telephone Industries) has been cited as placing substantial additional resources at the disposal of these undertakings, whereas similar facilities are not available to the State Public Sector Enterprises.

Small Savings and Special Deposits Scheme

Several States have pointed out that the States' share of two-thirds (since raised to three-fourth from April, 1987) in the additional small savings collection should be enhanced and that such loans should be treated as 'loans in perpetuity'. A specific suggestion made by a State Government is that the repayment period and moratorium allowed on small savings loans should be doubled. It has also been alleged that through the Special Deposits Scheme the Union Government has acquired access to substantial investible funds of the Provident Fund Organisations and has thus reinforced its budgetary position at the expense of the States. 

Indebtedness 

Some States have complained that the present pattern of Union transfers, with preponderance of loans, is completely out of line with their pattern of expenditure and repayment capacity and have demanded a review. 

Channelling of External Assistance  

Another grievance of the States is that the Union Government obtains external assistance on concessional terms, but the benefit of the same is not correspondingly passed on to the States.  

Overdrafts and Deficit Financing 

Some of the States have argued that persistent large overdrafts reflect a fundamental disequilibrium in their finances. Further, more often than not, large overdrafts result from situations beyond their control, including delays in releasing of Central transfers and genuine unforeseen expenditures. They point out that while the Union Government has an easy and regular access to deficit financing, the overdrafts of the State Governments need not be grudged. The significant difference in the rates of the interest between the two is often cited as an instance of discrimination. 

Natural Calamities

 There are complaints of delay, inadequacy and even discrimination in providing relief for major calamities which need to be dealt with as a matter of national concern. 

Union Expenditure on States' Subjects  

It has been pointed out by some of the States that the Union Government incurs substantial expenditure on several subjects, belonging to the sphere of the States (e.g., agriculture, rural development, cooperation, health and irrigation) through the Centrally Sponsored Schemes and by maintaining large establishments. These have, on the one hand, allegedly deprived the States of substantial transferable revenues and, on the other, distorted their priorities by requiring them to find matching funds for the schemes sponsored by the Union Government. 

Expenditure Control 

Most of the State Governments feel that the functioning of the existing institutions— Comptroller and Auditor General and the Public Accounts Committees of the Parliament and State Legislatures—should be strengthened for improving expenditure control. A State Government has, however, complained that the present centralisation of audit result in procedural delays. It is pointed out that accounts are finalised with gaps of three to four years. In this connection, it has drawn attention to Section 167 of the Government of India Act, 1935 which empowered a Provincial Legislature to create the office of an Auditor-General. Another State Government has stated that considering the desirability of evaluation audit, it should be entrusted to an agency constituted by the State Government itself.  

Expenditure Commission  

 Many States have emphasised that there is need for a through examination of the Union Government's expenditure since this has implications for resources available for transfer to the States. Some have suggested that this should be done by an Expenditure Commission as the existing mechanisms are inadequate for this purpose. 

Institutional Finance 

Union Government's exclusive control over the policies and resources of the Banks and the Public Sector financial institutions is also one of the irritants in UnionState financial relations, although these are Union subjects. The fact that more than half of the loans from the public sector financial institutions have gone only to two States, has been adversely commented upon. In this connection, some suggestions have been made for setting up a National Credit Council having representatives of the State Government on its panel. 

Financial Indiscipline 

The Union Government has, on the other hand, drawn attention to the considerable increase in transfer of resources to the States over the years, particularly during the last three Plan periods. The demand of the States for financial assistance to deal with natural calamities has expanded 3 to 4 times in recent years, showing inadequate financial control and discipline.

The issues in Union-State financial relations revolve round the States' case for having access to more resources in a situation of overall resource shortage. Interlinked are the problems regarding the patterns and modes of Central transfers, relative revenue mobilisation efforts, prudence in incurring expenditure, sharing of the community's savings, deficit financing, etc. There is a demand for greater objectivity and automaticity in resource transfers and allocations.

Transfers from the Union and their growth

An analysis of data relating to resource transfers to the States from the Union reveals certain interesting facts. On revenue account, perior to transfers to States, the Union Government's share has been stable around two-thirds of the combined revenue resources of the Union and the States. On capital account, its share was 85.4 per cent during the period 1951-85 and that of States 'own' resources 14.6 per cent.

Transfer of total resources during the period 1951-85 from the Union to the States has been substantial, being 22.6 per cent of the combined aggregate resources. As a percentage of the total resources raised by the Union, the transfers to the States accounted for 31.6 per cent. As a result of these transfers the resources of the States became a little over half of the combined resources of the Union and the States. Transfers to the States during the period 1951-85 have increased from Rs. 1,307 crores during the First Plan period (1951-56) to Rs. 56,031 crores during Sixth Plan period (1980-85) showing an annual trend growth rate of 13.67 per cent. This brings out the significant role of the resource transfers to the States.

Revenue and Capital Transfers

Further break-up of the transfers in terms of revenue and capital shows that on revenue account, the transfers to the States have been approximately three-fourths of the total transfers. In the initial years (1951-56) the transfers on revenue account were about 46 per cent. Thus, the revenue account transfers have not only shown volume growth but also as a percentage of the total transfers they have risen steadily from 46 per cent to 73 per cent. The trend growth rate of transfers on revenue account works out to 15.60 per cent per annum.

Pattern of Transfers

It will also be pertinent to consider the pattern of transfers. Resources are transferred partly on the recommendations of the Finance Commission, partly through the Planning Commission and also directly from the various Ministries of the Union Government. We have considered in detail the pattern of devolution in Section 7 and the salient features are noted below.

The transfers on account of the Finance Commission have gone up from 31.2 per cent in the First Five-Year Plan period to 41.3 per cent in the Sixth Plan period.Transfers on the recommendations of the Planning Commission show considerable fluctuations during this period. During the last two Five-Year Plan periods, they were around 42 to 43 per cent. These transfers include those on account of Central and Centrally Sponsored Schemes. These were only 2.8 per cent during the period 1966-69 (i.e., after the Third Plan) and have gone up to over 11 per cent in the Sixth Plan Period. During the last two plans, 'other transfers' were 15.0 and 15.3 per cent respectively.

Another interesting aspect of these transfers is seen in the split between Revenue and Capital components. Transfers through the Finance Commission have been almost wholly on revenue account. Out of these revenue transfers, 85.1 per cent were by way of tax-sharing and the remaining 14.9 per cent were in the nature of grants or sharing of other resources for the period 1952-84. On the other hand Plan transfers carry a large loan component.

Taxation by States under Articles 287 and 288

A State Government has suggested that the States should be allowed to levy tax on power sold to the railways as the railways are a commercial organisation. Article 287 lays down, among other things, that save in so far as Parliament may by law otherwise provide, no law of a State shall impose or authorise the imposition of a tax on consumption or sale of electricity consumed or sold to Government of India or consumed by the railways.

Further, a suggestion has been made that Article 288(2) may be suitably amended to enable the State Legislature to impose a tax in respect of water or electricity stored, generated, consumed, distributed or sold by any authority whether subservient to the Union or a State Government. The proposal seems to imply removal of preconditions under Clause (1) of that Article requiring President's prior approval for effecting such a legislation by a State.

Indian railways constitute a basic infrastructure. With the gradual shift from coal and diesel to electric traction, the consumption of power by railways is likely to increase. In the construction and maintenance of railways works, the consumption of electricity by railways may significantly add to its costs. In our opinion this may have serious repercussions on the extension and operation of railways. We, therefore, do not agree with the suggestion that the States should be given unrestricted power to levy a tax on electricity sold by the States to the railways by effecting an amendment to Article 287 of the Constitution.

An all-India political party has suggested that the States should be permitted to tax generation of electricity within their areas as distinguished from mere sale of electricity. The basic principle followed in the Constitution in the division of taxation powers between the Union and the States is that tax on production, with a few exceptions is levied by the Union and on sale by the State Governments. In our opinion, this principle is germane to taxation of electricity also. Electricity is an imporant ingredient of infrastructure. While its generation has to be location-specific in most cases, its consumption may be of inter-State significance. Even on taxation of inter-State sale of electricity, limitations have been put on States' powers, vide Article 288. A tax on generation of electricity by the States, if allowed, might operate as an additional barrier to inter-State flow of this strategic input. In view of these considerations, we do not agree with the suggestion that the States may be allowed to levy tax on generation of electricity.

Taxation of Agricultural Income

An all-India political party has submitted to us as follows:
"Under Entry 46 of the State List, the State can levy tax on agricultural income. Because of the efforts as to the enormous expansion of irrigation facility, hybrid seeds, chemical fertilisers and research in soil fertility, a very large number of agriculturalists have come to occupy the upper bracket of elite group in the society. Green Revolution to the extent of burgeoning stocks of Food Corporation of India, search of export market of wheat and rice and ever-rising support prices for agricultural products have combined to bring into existence an affluent class of agriculturists. Yet, save Kerala no State has levied agricultural income tax........It is a truism that State Governments in order to keep intact their vote banks do not levy taxes and shed crocidile tears of shortage of resources."
A suggestion often made is that in order to overcome the resistance by interested groups and in the interest of uniformity in taxation, the union may levy a tax on agricultural income and its net proceeds be assigned to the States.

The Government of India Act, 1935 empowered the Provinces to levy tax on agricultural incomes while the income tax on other incomes was allotted to the Federal Government. This division was retained in the Constitution. At present, about half a dozan States are levying Agricultural Income Tax. In three of them, it is confined to plantation crops. Several States, which had been earlier levying taxes on agricultural incomes, gave them up or are collecting only nominal amounts following various exemptions.

 Several States have highlighted serious problems in the assessment of agricultural incomes; shrinkage of the tax bases due to land reforms (ceiling on holdings); widely dispersed potential assessees; fluctuations in production and incomes due to vagaries of nature; problems in maintaining systematic accounts of income and expenditure in agriculture, etc. A few State Governments are of the view that a direct tax on agricultural incomes will act as a disincentive to the spread of improved technology and high productivity.

The State Governments have generally expressed reservations and have opposed the suggestion that the Union Government may levy a tax on agricultural incomes and assign the net proceeds to the States. They have given different reasons for the same. Those already levying the tax on agricultural incomes are of the view that there will be no additional advantage if the tax is levied by the Union Government. Others have highlighted the difficulties in levying Agricultural Income Tax and pointed out that the Union Government will face similar problems. Indeed, according to them there is not much scope for such a tax: Some of them have also expressed apprehensions about the alternative of the Union levying the tax and have cited the 'unhappy' experience of the scheme of Additional Excise Duties in lieu of Sales Tax. Yet another State Government has argued that it was not so much a question of raising revenue as of a State's discretion to levy or not to levy a tax. Another State Government has pointed out that fixation of agricultural prices at levels much lower than those recommended by the States is already a tax in disguise on the agricultural sector. Only one State Government has suggested that in the interests of raising revenue and a uniform tax on agricultural sector, the Union Government might levy this tax as per arrangements under Article 268.

The Union Ministry of Finance has observed:
"The Central Government has no intention of seeking a transfer of power to tax agricultural incomes on behalf of the States for the following reasons:
While there may be justification for imposition of agricultural income tax in view of increased income due to the Green Revolution, substantial investment in the agricultural sector, low revenues raised from the agricultural sector, and greater need for raising additional resources for development, there would, however, be serious difficulties in the implementation of this policy at the Central level due to conceptual difficulties regarding the definition of agricultural income. No uniform definition of agricultural income can be precisely formulated due to diversity of the quality and productivity of land. Moreover, due to the illiteracy of the agricultural population, agriculturists would not be able to maintain accounts for taxation purposes and may not be able to follow the rules and regulations prescribed. Besides, some sort of agricultural income tax is already being levied by a few States and others could follow suit."

Taxation of agricultural income is, indeed, a sensitive matter requiring simultaneous consideration of an appropriate base, administrative convenience and costs, reasonable yield from the tax, parity with tax burden on non-agricultural sector: peculiar nature of agriculture as an enterprises, impact of the tax on productivity-improvements in agriculture and the like. Both the Union and the State Governments do not also at present seem to be inclined for a change in the Consitutional provision in regard to Entry  of List II. We have also taken note of the findings of a number of expert studies in this regard. In view of the problems highlighted by the Union and the State Governments as well as the expert studies, the question of raising resources from this and other related aspects would require an indepth and comprehensive con-sideration in the National Economic and Development Council.

PATTERN OF DEVOLUTION

We have noted that the devolution of resources from the Union to the States has been very significant. These transfers are crucial in effecting a balance in the sharing of over-all resources between the Union and the States and their distribution among the States inter se. Following are the important issues that have been raised in respect of the pattern and efficacy of devolution of resources from the Union to the States:

(i) The devolutions effected on the recommendations of the Finance Commission—a body which has its origin in the Constitution—constitute only a part of the total transfers. Bulk of the transfers made for the Plan and other purposes under Articles 282 and 293 are 'discretionary', and by implication allow free play to the Union Government's choice in respect of their magnitude and allocation. It is alleged that the expectations of the Constitution-makers that the devolution of resources from the Union to the States through the mechanism devised by them, in an impartial and 'automatic' manner free from 'interference', has suffered change.
(ii) some expert studies have highlighted the iniquitous nature of the Central transfers with respect to allocations among the States. A few less-developed States have suggested special dispensation to them in Centreal transfers. Apart from the above issues, another aspect is whether the Union Government is transfering sufficient resources to the States. Before considering the above-mentioned issues, we may briefly review the factual position on the pattern of devolution of resources from the Union to the States.
Pattern of Transfers
 Devolution of resourcs from the Union to States may be placed under three categories:
(i) transfers based on the recommendations of the Finance Commission:
(ii) transfers by way of assistance for execution of the Plan recommended by Planning Commission, including Centrally Sponsored Schemes; and
(iii) Others consisting of small savings loans, assistance for natural calamities, etc. canalised through the Union Finance Ministry.

Statutory transfers
 Transfers effected on the recommendation of the Finance Commission (called by some as 'statutory transfers') are normally determined for a period of five years. Bulk of these transfers are unconditional and have a built-in buoyancy with respect to the growth of the concerned tax receipts. In the totality of resource-transfers, those on the recommendations of the Finance Commission accounted for 40 per cent during the period 1951—85.
Central Plan Assistance
 A substantial part of the transfers in the second category are by way of assistance for the execution of the State plans. These accounted for 31 per cent of the total resource transfers from the Union to the States during the period 1951—85. If to these transfers are added those on account of Central and Centrally Sponsored plan-schemes, the totality of plan transfers during the period 1951—85 works out to about 41 per cent of the total transfers. The Central assistance for the plan is based on the recommendations of the Planning Commission. It includes both loans and grants. During the Sixth Plan period the grant component in the total plan transfers was about 56 per cent. A large part of the Central assistance for the State plans is allocated on the basis of the Modified Gadgil Formula34 and other pre-determined considerations. We have discussed and commented on this aspect in detail in the Chapter on Economic and Social Planning.
Other Transfers
 Besides the transfers effected on the recommen-dations of the Finance Commission and on plan account, the Union Government gives grants and loans for various other purpose, like relief of natural calamities, improvement of roads, upgrading the salaries of teachers, relief and rehabilitation of displaced persons, etc. These comprise the third category. During the period 1951—85 such transfers accounted for about 19 per cent of the total transfers.

Transfers on Revenue Account
 The pattern of Central transfers on revenue account shows that the transfers on the recommendations of the Finance Commission, comprising tax-shares, grants-in-aid under Article 275(1) and grants in lieu of the other taxes, in the various Plan periods have generally been well over 60 per cent of the total transfers on revenue account. The 'shares in taxes' and grants-in-aid under Article 275(1) have reinforced each other to maintain a fairly stable share of such transfers taken together. The share of 'other grants' under Article 282, which are given as part of the Plan assistance for the various schemes of the Union Ministries, natural calamities, etc., outside the purview of the Finance Commission, has been significant and, on the average, a little over 37 per cent.
Transfers on Capital Account
The position of the States is significantly different on capital account as their borrowings other than the Central loans-reckoned as their 'own' resources are also to be allowed by the Union Government in accordance with Article 293 of the Constitution. Transfers to the States for financing rapidly increasing Plan outlays have been largely in the form of Central loans (gross). The trends in the pattern of States' indebtedness Signify more than 70 per cent share of the Central loans in States’ indebtedness and also a declining share of their internal debt—from the market and financial institutions.
Transfers and financing of States' Expenditure
Financing of revenue expenditure of the States by different sources individually  and Cumulatively) throws further light on the respective roles of States' own resources, Central transfers, the pattern of Central transfers and trends in States' finances. The 'own' resources of the States on the average have had 62 per cent share in financing their revenue expenditure. However, the 'share in taxes', which is the category most preferred by the States in view of its statutory and condition-free status and buoyancy, has been signifacant (23 per cent during 1951—85) and rising over the period. The two together, constitute 85 per cent of the States' revenue expenditure during 1951—85. If to this are added, 'grants-in-aid of revenues under Article 275(1)’ and ‘grants in lieu of other taxes, etc., also given on the basis of the Finance Commissions recommendations, the total accounts for the financing of about 89 per cent revenue expenditure of the States. The scheme of financing of States' revenue expenditure resulted in an over-all surplus of 4.4 per cent during 1951—85, and has been quite substantial since 1974-75. The Statewise position would, however, show significant variations.
'Statutory' Vs. 'Discretionary' Trnasfers
 It is often alleged that inasmuch as only 40 per cent of the total transfers from the Union have been effected on the recommendations of the Finance Commission envisaged in the Constitution, the balance of transfers has been discretionay in character. It is contended that Article 282 was intended to be a sort of residuary Article to take care of unexpected kind of things, inter alia, for making marginal adjustments; but the Plan grants made by the Union in exercise of its power under Article 282 by assuming a dominant role in devolving resources to the States, have distorted the Constitutional scheme. We have noted that although the financial assistance given to the States on the recommendations of the Finance Commission has substantially increased since the period of the First Five-Year Plan the bulk of the transfers (close to 60 per cent during the period 1951—85) have been in the form of Plan and 'other transfers'.

This criticism has two aspects—One technical and academic, the other oblique and imputative. As regards the first, these transfers under Article 282 are discretionary only in a technical sense, as opposed to mandatory. Whereas sharing with or assignment to the States by the Union of the net proceeds of certain taxes mentioned in Article 270 and 269 (on the advice of the Finance Commission) is mandatory, there is no such Constitutional obligation on the Union for making grants to the States under Article 282. The oblique aspect of this criticism, however, raises the question whether in substance and practice, the transfers made for Plan purposes under Article 282 on revenue account to the States are discretionary in the sense that they allow free-play to the Union Government's choice in respect of their magnitude and relative allocation.
 So far as the Plan transfers are concerned the size of Central assistance for the Plan is determined as a part of the exercise for the financing of the Five-Year Plan, which is approved by the National Development Council on which all the States are represented. Any increase in the actual devolutions to the States over the Five-Year Plan estimate corresponds to the assessed needs for the Plan on annual basis. This is effected on the advice of the Planning Commission. Indeed, there has not been any criticism from the States on increasing the flow of Central Plan assistance to them as compared to the Five-Year Plan estimate or on its inter-Sate allocation. So far as the allocation of Central assistance for the State Plans is concerned, as has been discussed in detail in the Chapter on Economic and Social Planning, bulk of it is decided in terms of the Modified Gadgil Formula and other objective determinants and special investments (including Tribal and Hill Areas Sub-Plans) which are also approved by the National Development Council and are subject to review by that body. These do not leave any significant discretion to the Planning Commission which is confined to only 10 per cent allocation of Central assistance under the Modified Gadgil Formula. In the case of the Centrally Sponsored Schemes also, the pattern of financing, viz., Central assistance vis-a-vis States' own contribution, for the various schemes is determined and known well in advance. The States have also not objected to the flow of Central assistance as such in this respect. The thrust of their complaint is on the system of matching contribution and their allegedly inadequate involvement in the formulation of these schemes. These aspects, though otherwise very important should not confuse the issue in question. We have dealt with them in detail in the Chapter on Economic and Social Planning.

So far as the category of 'other transfers' (for natural calamaties, etc.) is concerned, the variety of purposes for which they are made by their very nature cannot be sufficiently anticipated by either the Finance Commission or the Planning Commission. Such transfers are purpose-specific and have to cater to the contingent problems which arise from time to time. These transfers being mostly on revenue account, do not carry much repayment liability on the part of the states. The States have not voiced any serious complaints against these transfers. The Study Team of the Administrative Reforms Commission, which examined in detail the use of Article 282 for such grants observed that 'a Constitutional amendment defining or restricting the scope of the Article is, therefore, not necessary, specially because to meet unforeseen situations, the Centre should have a degree of flexibility in the use of The Article.'35 We fully endorse this observation.

 In view of the above, the Plan and other transfers which are labelled 'discretionary' do not amount to a subversion of the Constitutional scheme. They cannot be considered either unreasonable or discretionary in a literal sense as their allocation follows predetermined criteria, or is tied to meet specific requirements of the States. The large magnitude of Plan transfers should not pose any controversy in this regard as the framers of the Constitution could not anticipate the extent of development resource-needs under the Plans of the States. The significant growth of Central assistance to States for planned development is, indeed, a natural response to such needs. The crux of the matter is that the States' participation in the planning process should be such that the Plan transfers are treated by them as part of a commonly agreed programme for the deployment of the nation's resources. We have discussed at length this aspect in the Chapter on Economic and Social Planning. In addition, in Section 8 we have dealt in detail with the controversy whether the Finance Comission could also attend to the assessment of financial requirements for the Plan.

 We are of the view that the controversy between statutory vs. discretionary transfers to the States is based more on theoretical than realistic considerations. It is not humanly possible to devise fool-proof formulae which would make the totality of Central transfers conform fully to the ideal of 'automatic and free-from-interference' devolutions. Some amount of flexibility and room for subjective judgement willhave to be left to the concerned institutions to deal with the specific situations as they arise. What is really important is that the institutions involved should function in a fair and non-partisan manner and take decisions with due discernment and expertise, which are implicitly acceptable to the States.

Equity in Transfers

An important direction of enquiry in the Union-State financial relations is whether the transfers from the Union to the States have satisfied the basic principle of equity. The Directive Principles of State Policy enshrined in the Constitution require that the 'State' should strive to minimise inequalities amongst groups of people residing in different areas. In our country, both inter-State and intra-State disparities are glaring and persistent in the backdrop of overall under-development. Lack of adequate financial resources has been recognised to be one of the basic constraints in the development of the backward areas. Provision for necessary administrative services, social and industrial infra-structural facilities is crucial for mitigating regional disparities.

A number of empirical studies have been made to ascertain how far the transfers effected have been progressive.  The findings of the various studies indicate broadly that the transfers on the recommendations of the Finance Commissions and the Planning Commission have not been significantly progressive in earlier years. However, during the last three Five-Year Plan periods there has been considerable improvement in this regard. Transfers falling in the category of 'other transfers', which are mostly purpose-specific, have been found to be generally regressive, tending to dilute the progressivity of overall transfers to the States. Similar has been the pattern of allocation of the institutional finance from the commercial banks, term-lending financial institituions, etc. On the whole, several of the less-developed States have been getting less that the average per capita devolution and share in institutional finance. this has contributed to the persistence of regional disparities in the country.

 Finance Commissions carry out a reassessment of forecasts of revenue receipts and expenditure (on non-plan account) of the States before determining the devolutions necessary. Their formulae of tax devolutions have generally resulted in leaving substantial surpluses with about half the number of States. In the case of States still remaining in deficit, grants-in-aid under Article 275(1) have been given to make good the assessed gaps and needs. Resources of different States differ considerably owing to widely varying levels of development. Five or six States which have a better resource-base have surpluses from their own resources. Any further devolution only adds to their surpluses. Some other States, though not as well-off in respect of their own resources, reach the stage of surpluses consequent upon devolution of resources by the Finance Commission.

The weightage given to population size, which is essentially a scale factor, as a major criterion in the formulae of devolutions, when combined with other criteria, has resulted in lower per capita transfers to the less-developed States. The last two Finance Commissions, however, sought to evolve formulae with greater progressivity, by further emphasising the poverty criteria.

 However, during the five-year period, on account of inflation, States' expenditure has gone up. To some extent it is compensated by increase in revenues on account of buoyancy in tax receipts. The States with revenue surpluses are better equipped to meet the adverse impact of inflation. On the other hand, grants-in-aid being fixed for most part, the effect of inflation is felt much more by the States in receipt of a larger proportion of grants. These States are precisely those which are less developed and lack the essential infra-structure which alone can enable them to develop quickly. The Seventh Finance Commission had observed as under:
'.a Finance Commission's scheme of transfers which leaves a few States with substantial surpluses on revenue account which can be ploughed back into fresh investments, and the rest of the States with a zero surplus, could contribute to widening of the economic disparities.'

The application of the modified Gadgil Formula (increasing the weightage of the 'States having per capita income below the national average' from 10 to 20 per cent in lieu of the 'expenditure on continuing irrigation and power projects') and provision of special Central assistance for the Tribal and HillAreas Sub-Plans, North Eastern Council and Special Component Plans, has made the allocation of Central Plan assistance more progressive.

 Many suggestions have been placed before us in regard to the basis for inter-State allocations. The less-developed States have argued strongly in favour of formulae which would place more resources at their disposal. On the other hand, the States with revenue surpluses have pointed out that they have their own peculiar problems, e.g., management of large metropolitan cities which, while generating resources, also require very large investments for providing essential services.

Backward Areas
Provision for the special needs and basic requirements of the backward areas, particularly in the backward States, would necessitate increasing attention to them in the allocation of funds by way of special provisions on soft terms over and above the general formula devolutions. The Union Government has a crucial role in helping the backward areas to get over the initial handicap of poor basic infra-structure. This would involve investments which may not produce returns for long years and, for the gestation period, need subsidisation by the Union Government. It is, indeed, in the long-run interests of the backward regions, and the country also, that by creating stimuli for development, they are helped to generate their own resources, rather than remain dependent indefinitely on the largesse of the Union, or the State Government, as the case might be. At the same time the overall resources being scarce, there is need for caution to ensure that the incentives given to the backward regions for accelerating their development do not, in the reverse, jeopardise for want of resources, the tempo and levels of development achieved in the relatively developed areas.

The financial problems of backward areas are, indeed, challenging and involve both availability of sufficient financial resources and their effective utilisation. It will be necessary to ensure that the less-developed or backward areas and States get adequate resources to meet their special requirements and bring their standards of administration at par with the advanced States. Both the Finance Commission and the Planning Commission will have to take coordinated and concerted action in devolving adequate resources to the less developed States and those having large backward areas. The Planning Commission will have to take a comprehensive view of the flow of Central investment and other institutional finance to the less-developed areas. Suitable institutional mechanisms need to be devised to ensure financial support and tying-up of the funds to the specific projects in such areas.
 

Union's Finances and Transfers
Another issue which is important in the context of Union-State financial relations is whether the Union Government has been making reasonable transfers to the States and, further, whether these could be significantly enchanced. The Union Government has been transferring about one-third of gross resources raised by it to the States—the revenue account transfers showing an upward trend. Transfers from the Union continue to play an important role in meeting the expenditure of the States.

It is significant that since 1979-80 the Union Government has been running a deficit on revenue account. The Balance from Current revenues became negative in 1985-86. During the Seventh Plan period, the Balance from Current Revenues has been estimated at (—) Rs. 12,011 crores. Thus, over the last several years the Union Government has been finding it increasingly difficult to meet its obligations on revenue account from its current budgetary resources and has had to take recourse to meeting them from borrowed funds.

Approximately three-fourths of the non-Plan expenditure of the Union now consists of defence, interest payments and subsidies. In recent years, massive anti-poverty programmes have been taken up and these have added substantially to the revenue expenditure. Of the total receipt (gross) in 1986-87, defence interest payments and subsidies absorb 36 per cent, transfers to States and Union Territories 29 per cent, leaving 22 per cent for Central Plan and 13 per cent for Union's non-Plan expenditure.

 The broad analysis of the pattern of Union Government's expenditure on revenue account beings out that while on development side expenditure on high priority items has been provided, in the non-developmental component, because of compulsions of defence, interest payments, subsidies, etc., not much manoeuvrability exists. Further, in addition to transfers of resources in the form of tax-shares and statutory and Plan grants substantial expenditure on subsidies and Central Sector and Centrally sponsored Schemes goes to benefit the States. The Union Government is thus already transferring substantial resources to the States. Under the present circumstances, there is need to pay attention to structural changes in transfers for which there is apparently greater scope.

 However, the resource needs of the States also are not to be understated. The over-all situation, therefore, calls for all-out efforts to raise resources, increased rationality in their allocation at the two levels of Government, a judicious priority-ordering and improved efficiency in resource-management.
 

Pattern of expediture of Union and States

The over-all expenditure of the Union and the States has grown rapidly especially in the wake of the fast-rising Plan expenditure. The annual trend-rates of growth work out to be 14,30 per cent in case of the Union and 13,52 per cent in case of the States for the period 1951—85. The proportion of developmental expenditure on revenue account has been rising in the case of the Union as well as the States.  On capital account, an overwhelming part of the expenditure is incurred for developmental purposes. Net disbursements of loans account for about half of the Union's capital expenditure and more than one-third of that of the States. Development loans constitute about three-fourths of the loans disbursed.

 Several experts have pointed out that substantial expenditure is incurred by both the Union and the state Governments on schemes which have come to be known as populist measures. These are often uneconomic but are supposed to earn popularity for the sponsoring Government. It will be in the best interests of the concerned Governments to take explicity into account the high opportunity-cost of such schemes and to examine whether any important programmes of development are compromised due to such diversion of scarce resources.

 The Union Government provides directly large subsidies for a number of items of which fertilisers subsidy, food subsidy and subsidy for promotion of exports, constitute the bulk. The State Governments also give subsidies on schemes of food and nutrition, interest payments and on certain schemes for the benefit of the weaker sections. Apart from subsidies which can be directly seen as such, subsidisation is also inherent in a variety of measures, e.g., exemption fully or partially from a tax or duty; allowance to channelise investments into particular sectors; refund of certain taxes to exporters, etc. Cross-subsidies are given by public corporations to particular groups of clients at the expense of others.

 The total amount of

(i) direct,

(ii) indirect and

(iii) cross-subsidies

is thus very large. The share of direct subsidies has been substantial since 1977-78. Unfortunately, no reliable estimate, especially of indirect and cross-subsidies, is available. The need for keeping down the expenditure on account of these subsidies has been emphasised time and again. The essential point to recognise is that subsidies introduce a distortion in the economy. Flow of resourcee is directed away from sectors to which they would have normally been applied. It is not to suggest that all subsidies are per se wrong. But it is very important to scrutinise to whom the benefits are realy flowing. Each type of subsidy needs to be carefully reviewed from the point of view of overall impact on the economy and consideration of growth with social justice.

 It is necessary that a comprehensive paper on direct, indirect and cross-subsidies, covering both Union and State Governments, is prepared by the Planning Commission every year and brought up before NEDC for discussion since the increasing burden of subsidies has a direct relevance to the availability of resources for the execution of the Plan.
Union's Expenditure on State Subject.

It has been pointed out that the Union Government incures a lot of expenditure on maintaining establishments and on schemes relating to subjects which fall in the State list or the Concurrent List of the Seventh Schedule, e.g., Agriculture, rural Development, Cooperation, Education, Health, etc. Bulk of such expenditure is channelised through the Centrally Sponsored Schemes either as grants or loans. In case of many schemes, the Union and the states share the expenditures. We have taken note of a study which has tried to project the issue empirically by showing that very high expenditure is being incurred by the Union Government, directly or through Central institutions, on Centrally Sponsored Schemes in violation of directives of the NDC in this regard, on subjects which belong to the States. We have dealth with various aspects of Centrally Sponsored Schemes in the Chapters on Economic and Social Planning and Agriculture.

ROLE OF THE FINANCE COMMISSION
Constitutional Provisions and Evolution

We have earlier noted the inevitability of substantial transfer of resources from the Union to the States. Another important aspect is the allocation of the resources so tranferred among the States with wide differntials in fiscal capabilities and needs. The Constitution provides for the setting up of a Finance Commission periodically for this purpose. Article 280(1) enjoins on the President to constitute a Finance Commission, within two years of the commencement of the Constitution and thereafter at the expiration of every fifth year or before, if it is considered necessary. Clause (2) of that Article impoweres Parliament to determine by law the requisite qualifications of its members and the manner of their selection. Clause (3) of the same Article enumerates the duties of the Finance Commission. It reads as under:
"(3) It shall be the duty of the Commission to make recommendations to the President as to—
(a) the distribution between the Union and the States of the net proceeds of taxes which are to be, or may be, divided between them under this Chapter and the allocation between the States of respective shares of such proceeds;
(b) the principles which should govern the grants-in-aid of the revenues of the States out of the Consolidated Fund of India;
(c) any other matter referred to the Commission by the President in the interests of sound finance."

It would be pertinent to consider broadly the position in this regard in some of the other federations in the world. In USA and Canada the idea of an independent or regular agency for this purpose did not find acceptance. The Australian Commonwealth Grants Commission is an advisory body established by an Act of Parliament and recommends on special grants to the claimant States or on any other issue referred to it by the federal government.

 In the absence of a well laid down and Constitutionally recognised institutional mechanism for revenue-sharing between the federal and unit Governments, in some of the countries numerous adjustments had to be resorted to. In the first place, because of concurrent taxation, in countries like USA, Canada and Australia, "which level uses what kind of tax and to what extent has been decided more by custom and negotiation, embodied in statute or agreement, than by constitutional provision".

 In USA, the tax system which came to be developed over the years is described to be 'uncoordinated and over-lapping. In Canada, recourse had to be taken to eleborate tax-rental arrangements. In Australia, at least in the initial years, the interests of the poorer states suffered. Even in West Germany, the Constitutional provision specifying the shares of the Laender (State) and Local governments, came to be incorporated between 1955 and 1967 after facing serious problems.

 The processes of inter-governmental transfers in other federations, besides other problems, are often intreicately linked with political understanding and have given rise to controversies. For example, in USA, federal grants are based on agreements enforcing strict conditionality on the State and Local governments. The shift towards general grants in 1982, accompanied by substantial overall cuts is understood to have created serious problems for the States to implement social programmes. In Canada, the policy of revenue equalisation grants has always been politically controversial. The trend towards 'provincialisation' of federal funds is said to have reduced the ability of federal government to redistribute financial resources and has brought up the question of national standards. In Australia, the Commonwealth Grants Commission recommends special purpose grants to the claimant States, but the general grants are determined largely on the basis of discussions at the political level. In West Germany, the problem of matching the revenues and needs of the poorer States is sought to be solved through vertical and horizontal equalisation payments and inter-governmental grants and subsidies for special and joint projects.

 The Finance Commission in India, in contrast, because of its Constitutional status, constitutes as unique arrangement. he framers of the Constitution by building it into the Constitution and by making it an expert body, removed the devolution of resources from the arena of political bargaining. The role assigned by the Constitution to the Commission has been deliberately given an advisory character. In a technical sense its recommendations are not definitive or self-executing. Parliament has been given the supreme authority to oversee the action taken by the Union Executive on the recommendations of the Commission. This has been ensured by requiring the Union Government to place before each house of Parliament every recommendation made by the Finance Commission, together with an explanatory memorandum as to the action taken thereon.
Issues.

 The Constitutional status accorded to it and its functioning as a semi-judicial expert body has earned for the Finance Commission high regard of the Union and State Governments. However, some aspects of the working of the arrangements have attracted criticism. This criticism may be classified into four categories:
(i) Deficiencies in the institutional arrangements envisaged in the Constitution.
(ii) Constrainst imposed by the Union on the Finance Commission by prescribing certain terms of reference.
(iii) Non-implementation of important recommendations of the Finance Commission by the Union Government.
(iv) Problems arising out of the methodologies followed by the Finance Commissions.

 While many State Governments are of the view that the existing institutional arrangements are adequate, some of them desire that its functions should be enlarged. Some of them have drawn attention to the fact that since Finance Commission are established periodically, their approach has been inevitably somewhat ad hoc and there has been lack of continuity from one Commission to another. They have suggested a more permanent set-up. The various suggestions could be broadly classified as under:
(a) The functions of the Finance Commission be enlarged. It should also consider Plan and other transfers and/or undertake comprehensive annual/periodical reviews of the financial performance of the Union and State governments.
(b) The Finance Commission should be made a permanent or standing body to cope with enlarged responsibilities.
(b) The coordination between the Finance Commission and Planning Commission is very important and should be improved, so that an integrated view on the flow of Central assistance to the States becomes possible.
(d) It should be provided with a permanent and well-equipped secretariat to carry on studies and maintain operational continuity for the benefit of the subsequent Finance Commission.

 The Finance Commission's recommendations generally remain effective for a period of five years. Many changes take place during the period in the estimates made by the Finance Commission at the beginning. Some of the State Governments have drawn attention to the fact that their financial position is adversely affected by inflation and various actions of the Union during this period. There is at present no mechanism to take care of the impact of these changes and provide relief.

It is argued that only one agency should deal with all the transfer, as the present dichotomy between plan and non-plan transfers is unnecessary and creates avoidable problems arising from differences in estimates and norms. Since the Finance Commission is the only institutional mechanism envisaged by the Constitution to recommend de-volutions in all aspects it would be but appropriate that it should deal with the problems in their entirely. Another suggestion is that the two bodies should be merged.
Enlargement of Functions

There has been some divergence of opinion as to whether the jurisdiction of the Finance Commission under Article 275(1) is limited to grants on revenue account, and capital grants needed to meet expenditure on Plan schemes are outside its purview. The First Finance Commission was of the opinion that this problem has to be considered "in the larger perspective of ensuring an equitable allocation of resources among the units". On this broad premise, the Commission recommended special grants-in-aid to eight States for development of primary education. The Second Finance Commission took a different view. In its opinion, there was no scope under Article 275(1) for special purpose grants for removal of inequalities in the standards of basic social services in States and that this function in a planned economy belonged to the Planning Commission and the National Development Council. The Third Finance Commission took a view similar to that of the First regarding the broad scope of Article 275 and recommended 'special grants' to ten States for development of communications.

The issue was clinched by the Fourth Finance Commission when it observed:
"The Constitution does not make any distinction between plan and non-plan expenditure, and it is not unconstitutional for the Finance Commission to go into the whole question of the total revenue expenditure of the States. It has been pointed out to us that the reference to "Capital and recurring sums" in the first proviso to article 275(1) of the Constitution suggests that even capial expenditure need not necessarily be outside the scope of the Finance Commission. It is, however, necessary to note that the importance of planned economic development is so great and its implementation so essential that there should not be any division of responsiblity in regard to any element of plan expenditure. The Planning Commission has been specially constituted for advising the Government of India and the State Governments in this regard. It would not be appropriate for the Finance Commission to take upon itself the task of dealing with the States' new plan expenditure."

 The Fifth Finance Commission also held that in the language of Article 275, "there is nothing to exclude from its purview grants for meeting revenue expenditure on Plan schemes, nor is there any explicit bar against grants for capital purposes" However, its terms of reference required it not to take into account the Plan for purposes of recommending grants-in-aid under Article 275. It did not even agree to recommend grants for higher expenditure outside the Plan on specific social services for improving their levels "as it would blur the entire division of functions between this Commission and the Planning Commission."
 One of the terms of reference of the Sixth Finance Commission enjoined it to assess the non-Plan capital gap of the States for the period 1974-75 to 1978—79. Adopting a pragmatic approach, the Commission described "the separation of revene from capital expenditre and of non-plan from plan expenditure" in re-assessment of States' forecasts as one of the "ground rules."

The approaches of the Seventh and the Eighth Finance Commission marked a significant departure from the earlier one. They recommended some capital grants for the upgradation of levels of administration. The eighth Finance Commission, recommended capital grants in Health and Education sectors, which are included among developmental sectors, treating them as essential non-plan earmarked capital requirements of the less-developed States. These recommendations were accepted by the Government of India. The observations of the Seventh Finance Commission on the issue need mention:
"We have given careful consideration to the scope for grant-in-aid under Article 275 for meeting capital expenditure. The operative part of this Article speaks of "sums". There is no restriction or bar in the Article for capital expenditure. The first proviso of the Article expressly speaks of grants of capital sums. This goes to show that the expression grants-in-aid of revenues does not limit grants for revenue expenditure only. We are fortified in this view by the note of the Chairman of the Fourth Finance Commission appended to its report on the interpretation of Article 275. Further, it seems unreasonable to hold that the operative part of the Article enables the Commission to make grants for revenue expenditure only, while the proviso enables grants being made of revenues as well as capital nature. It is quite clear therefrom that it is open to us to recommend grants for capital expenditure also, apart from grants for revenue expenditure under Article 275."

 The Union Ministry of Finance in response to a query on this issue, has provided the following clarification:
"It is settled policy of the Commission to cover the capital requirements of the States under the upgradation grants. In case the Commission on Centre-State Relations is alluding to the entire range of the capital requirements of the States during the forecast period, the roles of the finance Commission and the Planning Commission in that case will overlap. The Planning Commission which is primarily concerned with asset-creation is given the near-exclusive responsibility for catering to the capital requirements of the States by the mechanism of Plan assistance for the 5 year plans.The Finance Commission takes care of the capital requirements of States in non-developmental sectors by way of upgradation grants. It may thus be seen that even in recent years the Finance Commission have
imaginatively and progressively made use of Article 275 grants both for capital and revenue and both for developmental and non-developmental purposes. This is not-withstanding the fact that the Presidential Order of the Eighth Finance Commission refers to up-gradation requirements of non-developmental sectors only".

 Finance Commission is constituted periodically and works for a short period. Planning is a dynamic process and as such continuous appraisal and adjustments are essential. A static five-year frame would not meet the requirements of planning. The Planning Commission reviews annually the resources and plan needs of the States and recommends plan assistance. In a dynamic situtation, net resources avialable for transfer from the Union to the States towards Plan assistance will also be known only on a yearly basis. The necessary expertise, support and competence for dealing with such a situation has been developed by the Planning Commission. For obvious reasons, it would not be possible for the Finance Commission to perform such a role. Therefore, practical difficulties would arise if Plan transfers are also entrusted to the Finance Commission. The present division of labour which has developed over the years is that the Finance Commission advises on the non-Plan revenue requirements and non-Plan capital gap. In certain sectors, where the problem is clear and the numbers are reasonably sure, the Finance Commission has recommended capital re-source devolution also only to a limited extent.

 We are of the view that the present division of responsibilities between the two bodies, which has come to be evolved with mutual understanding of their comparative advantage in dealing with various matters in their respective spheres, should continue. The present arrangements have also not given raise to any serious problems to necessitate any change.
 

Coordination between Finance Commission and Planning Commission

 Need for greater coordination between the Finance Commission and the Planning Commission has been emphasised by many State Governments and experts. The Administrative Reforms Commission had recommended that in order to ensure greater coordination between the two bodies, one Member of the Planning Commission should also be nominated as Member of the Finance Commission. Since the Sixth Finance Commision, one Member is common to both the Commissions. It is however, a matter of concern that only two of the four common Members so far appointed were in charge of the Financial Re-sources Division in the Planning Commission. As this defeats the very purpose of having a common Member, we would suggest that the Member in-charge of financial resources in the Planning Commission should automatically be the common Member and remain in this charge even after the report of the Finance Commission is submitted. This arrangement would enable the adoption of an integrated approach in the assessment of financial resources and needs of the States by the two Commissions.
A precondition for smooth coordination between the two bodies is the synchronisation of Five-Year Plan period with the reference period of the Finance Commission. There is an impression that once the Finance Commission's report is submitted, it is not of much consequence beyond determining major parameters like tax shares, grants-in-aid, etc. A planned economy presupposes utmost financial discipline. The entire system of resource transfer built up on the basis of the recom-mendations of a semi-judicial body of experts would crumble in case there is scant regard for the norms evolved by it.

 We have already noted that Finance Commissions reassess the receipts and expenditure of the States on a normative basis. A perusal of the reports of the various Finance Commissions shows that practically all the Finance Commissions have had occasion to note that on the receipts side the norms determined by the preceding Finance Commission were seldom reached, particularly in regard to returns from irrigation and power projects and from State road Transport Corporations. On the other hand, on the expenditure side, the norms have been invariably exceeded. In many cases, large expenditure on new non-Plan items has been incurred. Sometimes schemes which could not be accommodated in the Plan have been included as non-Plan items and large sums spent on them. Finance Commissions build into their forecasts of expenditure certain amounts for maintenance of assets already created, e.g., irrigation schemes, buildings, road, etc. Often the amounts intended for mainten-ance of these assets have been diverted for other uses with very adverse impact on the upkeep of assets already created.

Finance Commissions have determined norms of returns from the irrigation schemes, State Electricity Boards and Road Transport Corporations. One of the terms of reference to the Sixth Finance Commission was to have regard, while determining the grants-in-aid, to "the scope for better fiscal management and economy consistent with efficiency which may be effected by the States in their administrative, maintenance, developmental and other expenditure". It observed that "with the increasing investments in irrigation and power projects and road transport undertakings, non-tax revenues in the form of interest receipts and dividends should be expected to become increasingly important in State finances."

 After detailed consideration of irrigation schemes it reached the conclusion that in the case of multipurpose river valley projects and commercial irrigation, the receipts should cover the working expenses. However, this was not achieved. The Seventh Finance Commission, while reviewing the some, observed that working expenses continued to exceed the receipts and that "complacency in this regard would be harmful and unjustified".

 The Eighth Finance Commission also observed that the norms evolved by the Seventh Finance Commission had not been met by the State Governments. The position is similar in the case of State Electricity Boards and Road Transport Corporations.

 We are of the view that these raise very serious questions in regard to fiscal management and financial discipline. In a situation of severe overall financial constraint. It is imperative that in-efficiency and imprudence in fiscal management is discouraged by evolving suitable procedures and systems of reward and punishment. We would emphasise that each Finance Commission should view with greater concern the violation of the regimen given by the preceding Commission and thus try to enforce a stricter discipline in checking wasteful expenditure.

The Finance Commission Cell/Division in the Planning Commission should continuously monitor the behaviour of the States' finances. It should also estimate annually the deviations from the norms evolved by the Finance commission. The Planning Commission would then be able to bring up before the National Economic and Development Council such annual reviews indicating, among other things, the deviations from the forecasts of Finance Commission and the reasons for the same. This would afford an opportunity to the National Economic and Development Council to monitor effectively and evolve consensus on the mobilisation of resources and contain the non-developmental expenditure.

 The Sixth Finance Commission observed: "Fiscal management is a multi-dimensional concept. In the application of this concept to concrete situations, both qualitative and quantitative aspects deserve attention. Briefly stated, in assessing sound fiscal management one should have regard both to the manner in which the State has endeavoured to raise the resources needed for meeting its commitments and also the manner in which it has deployed the resources so raised so as to get the best possible results for the expenditure incurred. A review of fiscal management in this broad sense will call for a comprehensive and critical survey of the fiscal policies and administration of State Governments over a period of time. This is a task which is too difficult to undertake within the limited time at our disposal."

During the interregnum between one Finance Commission and the appointment of the next Commission, the Finance Commission Division should in cooperation with the States, organise comprehensive studies in trends in growth of public expenditure in the States in the light of the findings of the previous Finance Commission. It shall also collect, study and analyse the data with reference to the relevant parameters which would help a more critical appraisal of the achievements and failings of the States in the fiscal sphere. The studies conducted by the Finance Commission Division should be available well in time for the use of the next Finance Commission. This Division can also, with the cooperation of the Union Ministries and agencies under their control, arrange similar review of the expenditure of the Union Government. Professional institutes, organisations and Universities aided by Union government funds, can also be involved in such studies.
 

Permanent Finance Commission, its Secretariat/Division

 Finance Commission has to deal with complex issues and the time available to it for the same is barely sufficient. Much of its time now spent on gathering data could be saved, if data collection is carried out on a continuing basis. Studies which may take time could also be organised in advance so that these are available to the subsequent Commissions and consideration of important matters would not be constrained for want of time. Two considerations are pertinent in this connection. Firstly, the Finance Commission is essentially an expert recommendatory body and cannot be expected to participate in active determination of the transfers on annual basis corresponding to changes in the economic situation. Indeed, the very scheduling of such exercises in an annual setting may be quite cumbersome and reopen a whole host of issues for consideration every year. Secondly, a measure of stability is desirable in the transfers and frequent changes may be very unsettling and counter-productive, giving rise to avoidable friction in Union-
State financial relations. We are, therefore, of the view that there is no need for a permanent Finance Commission.Special Considerations
 Another criticism relates to the 'considerations' which the Finance Commissions are asked to have regard to, among other things, in recomending grants-in-aid under Article 275. These are in addition to the special terms of reference as per sub-clause (3) (c) of Article 280. These 'considerations' it is alleged, have conditioned the methodology of the Finance Commissions.
In making recommendations, the Finance Commissions have been asked to have due regard, among other things, to certain 'considerations'. To illustrate, the Sixth Finance Commission was required to consider the require-ments of States' backwardness in general administration with a view to raising the levels to those of the advanced States over a period of ten years. Similarly, some of the 'considerations' listed for the Seventh Finance Commission were:
(i) the resources of the Central Government and the demands thereon on account of expenditure on civil administration, defence, border security, debt-servicing and other committed expenditure or liabilities;
(ii) adequate maintenance and upkeep of capital assets and of completed plan schemes as on a specified year and monitoring of such expenditure, and
(iii) the need for ensuring reasonable returns on invest-ments in irrigation and power projects, transport undertakings, industrial and commercial enterprises and the like. 
In the Presidential Orders constituting both the Seventh and Eight Finance Commissions it was stated that "the Commis-sion shall adopt the population figures of 1971 census in all cases where population is regarded as a factor for determination of devolution of taxes and duties and grant-in-aid".

 On this issue, the Union Govenment has communi-cated to us that the Finance Commissions are free to make recommendations on matters covered by Article 280, in any manner they deem fit. The Presidential Order in all these cases states that the Finance Commissions shall 'among other things' have regard to the listed considerations. These considerations are, therefore, to be viewed as "an illustrative list of the factors considered germane by the Government to the task of the Finance Commissions". The Union Government has observed that the stipulation that the population figures of 1971 census should be adopted wherever pupulation is used as a factor in making recommendations for either devolution of taxes or grants-in-aid is in keeping with the Family Welfare Policy approved by Parliament on June 29, 1977.
Finance Commissions have enunciated from the very beginning considerations to be kept in view by them while determining the grants-in-aid, e.g., fiscal needs, considerations of equity in resources allocation among the States, etc. They have also taken into account, while assessing the fiscal needs, the considerations listed in the Presidential Order. But these conditions, have not by themselves restricted their approach. In fact, the Seventh Finance Commission observed: "The Commission's freedom to take into account other factors is not inhibited".51 We note that a controversy has arisen in regard to the terms of reference of the recently constituted Ninth Finance Commission, particularly on para 4 of the Presidential Order which, it is alleged, binds it to follow a 'normative approach' and to take into account certain other aspects. In view of the reasons already stated by us in the preceding paragraphs, we are not covinced that any reference to Finance Commission unless constituting a term of reference vide Article 280(3) of the Constitution, can bind or delimit its approach. However, it will only be appropriate and befitting the statutory and high status of the Finance Commission that any considerations suggested to it, besides its terms of reference under Article 280(3), are put in a language which does not give an impression of formally binding it to adhere to a given approach or methodology.

Additional Excise Duties in Lieu of Sales Tax

 Another area where allegations of Union Government's inroads into States' sphere of raising revenue are made is the replacement of States' Sale s Tax by Additional Duties of Excise on selected commodities. This arrangement came into being after the concensus arrived at in the meeting of the National Development Council in 1956. Additional duties of excise in lieu of States' Sales Tax have since been implemented through the 'Additional Duties' of Excise (Goods of Special Importance) Act, 1957 covering millmade textiles, sugar and tobacco including un-manufactured tobacco. The receipts on this account are distributed among the States on the recommendations of the Finance Commission. The major considerations which weighed in evolving such 'tax-rental' arrangement as described by the Fourth Finance Commission, consisted of removal of administrative complexities and simplification of the structure of commodity taxation; preference indicated by trade, industry and consumer for excise taxation vis-a-vis sales tax; reduction in cost of collection and opportunities of evasion, and better collection and coordination keeping in view the total incidence of commodity taxation.

In their memoranda submitted to the Fourth and Fifth Finance Commissions, the State Governments complained that the receipts from additional excise duties were much lower than what they would have got if they had imposed sales tax on them. In pursuance of the recommendations made by the Fifth Finance Commission, the National Development Council in its meeting held on December 28, 1970, reviewed the arrangements and approved continuation of the scheme subject to :
(i) conversion of specific duties into ad valorem duties except in respect of unmanufactured tobacco;
(ii) the raising of the incidence of additional excise duties as a percentage value of clearance to 10.8 per cent 'in a period of two to three years'; and
(iii) achieving and maintenance of ratio of 2:1 between the yields of basic excise duties and the additional excise duties on these commodities.

A Standing Review Committee consisting of Central and State Government representatives was also constituted for reviewing the scheme. The committee suggested that the rate of 10.8 per cent be reached in phases, viz., 8.5 per cent by 1984-85, 9.75 per cent by 1987-88 and 10.8 per cent, by 1989-90. It also suggested that the States should not insist on 2:1 ratio of basic to additional excise duties till the incidence of additional excise duties of 10.8 per cent (with a total incidence of 32.4 per cent) was reached. Further, it was recommended by the Review Committee that the level of incidence should not be allowed to go below 7.4 per cent in future years. The Eighth Finance Commission expressed the hope that the above recommendations of the Standing Review Committee would be implemented by the Union Government within the time schedule contemplated. In 1984-85, the assurance regarding achievement of the incidence of 8.5 per cent of the value of clearances in respect of the additional excise duties was reached. The incidence of additional excise duties for 1987-88 is estimated at 9.90 per cent as against 9.75 per cent recommended by the Standing Review Committee. We hope that the level of 10.8 per cent of the net value of clearance will also be realised as per schedule indicated by the Standing Review Committee.

 On the recommendations of the Report of the Indirect Taxation Enquiry Committee, 1978 (Chairman : L.K. Jha), a proposal has already met with general approval of the Chief Ministers in their meeting in September, 1980 to extend the scheme of additional excise duties to five more commodities; (i) Vanaspati; (ii) Drugs and Medicines; (iii) Cement; (iv) Paper and Paper Boards; and (v) Petroleum products. Some of the State Governments have, however, expressed reservations about the proposed extension of the scheme.

This scheme of extension of Additional Duties of Excise was examined by an Expert Committee (Chairman : Kamlapati Tripathi) 1983, which, among other things, suggested formulae for distributing the revenue realisable by additional excise duties from the five commodities under the proposed scheme.

 On a consideration of the arguments given by the State Govrnments against the arrangement of additional excise duties in lieu of sales-tax, it has been observed that the problem is not so much with the rationale or principles involved as for not raising the tax to the level accepted by the National Development Council. The State Governments, in view of the past experience, do not feel assured with the formulae suggested and that the recommendations made by the Tripathi Committee would be duly honoured. One State Government has mentioned that this has happened because the decisions of the National Development Council have no statutory backing and that the recommendations of the Tripathi Committee might meet with the same fate resulting in considerable loss to the State Governments. Another State Government has challenged in the Supreme Court the provisions of the Constitution (Sixth Amendment) Act, 1957, Section 10 and 11 of the Central Sales Tax (Second Amendment) Act, 1958 and Additional Duties of Excise (Goods of Special Importance) Act, 1957.

 We note that whatever be the theoretical arguments in favour of levy of additional excise duties in lieu of Sales Tax, in practice, many problems have arisen. The experience of the States during the past decade and more, in regard to Additional Duties of Excise on mill-made textiles, sugar and tobacco has given room for genuine apprehensions. Unless these misgivings are removed by devising a suitable formulae acceptable to the State, any extension of the scheme to additional commodities is likely to create quite an amount of Union-State friction. We also note the document on long Term Fiscal Policy has stated : "Merger of additional excise in lieu of sales tax with basic excise duties, though desirable, is not feasible for the present as it would require evolving a suitable formula for allocating a part of the excise duties on textiles, tobacco and sugar for distribution among the States. The matter will be referred to the next Finance Commission for determination of a suitable formula.

Tax on advertisements broadcast by Radio or Television

 A State Government has made the following suggestions:
"A tax on advertisements should be imposed and the scope of Article 269(1)(f) may be widened to include, besides newspaper advertisements, advertisements broadcast by radio or telecast by television".

  States' power to levy tax on 'advertisements broadcast by radio or television' was precluded in Entry, List II by the Constitution (Forty-second Amendment) Act, 1976 in addition to the already existing exception in that Entry of tax on 'advertisements published in the newspapers'. But, whereas the latter had a corresponding mention in Entry 92, List I and Article 269(1)(f), the subject of tax on 'advertisements broadcast by radio or television' was not provided in the above-mentioned Amendment Act. We have not been able to get a satisfactory explanation for the same. The Union Ministries of Information and Broadcasting and Law and Justice have expressed the view that the rationale of amending Entry List II was that the revenue from advertisements broadcast/telecast by radio/television should be fully available for the development of these services. Further, a tax on such advertisements might seriously erode accrual of revenue from them. We are not able to agree with these views as a tax on advertisements would have to be additionally borne by the advertisers without cutting into the revenues accruing to the Union. In view of the fast-growing commercialisation and competition, any adverse indirect effect of such a tax on revenue from advertisements on television and radio shall not be serious. For example, a steep hike in rates of advertisements on television effected in February, 1987 did not result in reduced demand for advertisement time.

 As such, the implications of the amendment under reference amount to taking away the States' power in respect of taxation of advertisements broadcast on radio or television and, in addition, to denying them a share in the net proceeds, should the Union Government levy this tax (presumably under Entry 97 as it does not find a mention elsewhere in List I). This position appears quite anomalous to us. Such a tax, in principle, is on the same footing as the one on advertisements published in newspapers (Entry 92, List I)—only the media differ. It is, therefore, only logical that it should have found a place in Entry 92, List I and also been included in Article 269. As the television/telecasting network gets extended to large parts of this country, the revenue from this source is bound to increase fast. It will then be for the Union Government and Parliament to consider and exercise this power of taxation under this newly added head.

 For all these reasons, we recommend that the Constitution should be suitably amended to add the subject of taxation of 'advertisements broadcast on radio or television' to the present Entry 92, List I and Article 269(1)(f).
 

Grant in Lieu of Railway passenger fare Tax

The State Governments have expressed serious dissatisfaction with the inadequate grant given in compensation of the repealed Railway Passenger Fare Tax. Such a tax was initiated in 1957 in accordance with the Railway Passenger Fares Act, 1957. It was repealed from 1st April, 1961 in pursuance of a recommendation by the Railway Convention Committee on the ground that the tax had reduced the scope for raising railway passenger fares. The States have since been paid grant in lieu of the tax which was initially fixed at Rs. 12.5 crores per annum and raised to Rs. 16.25 crores from 1966-67 and again to Rs. 23.12 crores for the period 1980-81 to 1983-84. The Eighth Finance Commission has raised the grant to Rs. 95 crores per annum. The States have in the past felt dissatisfied about the fixed nature of this grant whereas the yield from railway passenger fares has increased manifold since 1961. Following this, a suggestion has also been made for reimposition of the tax. The successive Finance Commissions, while generally sympathising with the States' viewpoint, did not find reimposition of the tax advisable. The Eighth Finance Commission, however, found scope for levying the tax but observed that no such tax should be levied so long as the present arrangement of grants to States in lieu of the tax continues.

 By raising the lumpsum grant in lieu of the Railway Passenger Fare Tax, the Eighth Finance Commission has assuaged the feelings of the State Governments. While the matter, for the present, seems to have been settled amicably, for future we would only suggest periodical review and suitable adjustment of such lumpsum grant on the recommendations of the Finance Commission.

 We have also noted that the implementation of the above-mentioned recommendation by the Eighth Finance Commission was somewhat delayed. In the Explanatory Memorandum laid before Parliament the procedure of its consideration by the Railway Convention Committee was mentioned.

The Finance Commission makes recommendations to the President. It would be unfortunate if the recommendations of the Finance Commission are again subjected to detailed scrutiny by yet another body, only because of likely impact on a department of the Union Government. Such matters should be treated as internal matters calling for inter-departmental adjustments in the functioning of the Union Government. We recommend that the Union Government should signify its acceptance of the Finance Commission's recommendation in regard to this item also along with the other items while placing the Explanatory Memorandum before Parliament.
 

Impact of Dearness Allowance, etc.

A major complaint of the State Governments is that periodical upward revisions of pay, dearness allowance, terminal benefits etc., of the Union Government's employees cast considerable burden on their finances as there is pressure on them to raise the benefits to their own employees covering not only Government servants but also employees of local bodies, teachers, etc. Due to bunching of such expenditure-obligations, the burden on the States' budgets often becomes unbearable, particularly for the less-developed States, thus wiping out the availability of surpluses from current revenues for development. On the other hand, during the last few years, revisions in the rates of salaries and emoluments in many States have been frequent and substantial, and in some cases have overtaken the pay-scales and benefits of the Union Government's employees.

 The Finance Commissions have shown increasing concern with the States' expenditure requirements in this regard. The Eighth Finance Commission allowed dearness allowance upto an average of 520 points (All India Consumer Price Index Number with base 1960=100). However, the experience in this regard has been that the rate of inflation has been significantly higher than the original estimates on which such provisions were based. The burden and uncertainty in financial deployment due to dearness allowance, pay revisions, etc. has been faced by both the Union and the State Governments.
 We note that the Finance Commissions take into account the expenditure liability of the States with respect to dearness allowance, etc. and make a provision for the same. According to some States, this provision has proved inadequate due to the actual rate of inflation being substantially higher than the projected rate. But if inflation increases outlay, it increases revenue also. The permanent secretariat of the Finance Commission recommended by us should make an annual review of the situation. We recommend that, if in any year the net burden of the State seems unduly heavy, the Planning Commission and the Union Ministry of Finance should jointly evolve appropriate relief measures.
 

Royalty on Minerals, Crude Petroleum, etc.

 Some State Governments have alleged payment of inadequate royalty on minerals, petroleum, etc. extracted from their territories. The rates of royalty on minerals were to be fixed by the Union Government once in four years under Section 9(3) of the Mines and Minerals (Regulation and Development) Act, 1957. Following an amendment of the Act in 1986, this period has been reduced to three years. Similarly, in case of crude oil, the rates of royalty are fixed under the Oil Fields (Regulation and Development) Act, 1948. Section 6(A)(4) of this Act restricts the Union Government to fix the rate of royalty in case of any mineral oil not to exceed 20 per cent of the sale price of that oil at the field or well. The provision for considering the revision of the rates of royalty in the case of crude oil, etc. has been modified on persistent demand by the States to three years recently, vide Section 2 of the Oil Fields (Regulation and Development) Amendment Act, 1984.

 A major demand of the State Governments has been payment of royalty on an ad valorem basis and not on the basis of a specific amount per tonne, specially in view of frequent and sharp increases in the prices of many minerals and crude oil. A State Government has cited the Nehru Award of 1962 and Indira Gandhi Award of 1968 in support of its demand that the royalty on crude petroleum should be based on "full-posted price" rather than on an artificial selling price of indigenous crude. On the other hand, the State Governments have levied cesses, mineral rights tax and surcharge which are not uniform among the States. This is alleged to have imposed a discriminatory burden on the price of minerals over and above the rate of royalty.

The question of royalty on mineral products is an area where, besides providing adequate rates to the States, the principles of pricing policy, the real factors behind movement of international price of crude-petroleum, the implications of increase in the price of basic inputs, etc., are to be considered. We have dealt with these issues in our Chapter on Mines and Minerals. If there are administrative considerations against making royalties ad valorem, there are equity considerations against not revising them for 3 or more years in times of persistent inflation. As recommended therein, the review of the royalty rates on minerals should be made every two years and well in time, as and when they fall due. The same procedure should also apply to royalty on petroleum and natural gas.
 

Suggestions for new institutions

 While suggesting solutions to the problems in Union-State financial relations some State Governments, as also others, have suggested creation of new institutions. Such suggestions are made for two categories of institutions : (a) a machinery for consultations and discussion on issues on mutual economic interest between the Union and the States, and (b) institutions, with adequate representation of the States, also for specific purposes such as a Loans or Credit Council and an Expenditure Commission. The suggestions for the new institutions thus emanate from both a positive urge for a larger measure of consultation between the Union and the State Governments on financial and economic issues and from a feeling of arbitrariness in the approach of the Union Government to some matters.

 One State Government has observed : "A large part of the inadequacy in the functioning of Union-State financial relations as reflected in persistent grievances seemingly harboured by the States and the concern expressed by them before different forums could have been taken care of by providing effective means of consultation, on a regular basis, between the Centre and the States on all matters pertaining to financial relationship between them". Another State Government has suggested that consultation between the Union and the States on financial matters could be ensured by a Committee of Finance Ministers of the States presided over by the Union Finance Minister. Some others have suggested that it would be desirable if the views of the State Government are ascertained before moving a bill to levy or vary rate-structure or abolish any of the duties enumerated in Article 268 and 269. Granting of exemptions and lowering of rates of Income Tax, net proceeds of which are now sharable with the States to the tune of 85 per cent, by the Union Government is often cited as another area where the State Government should be taken into confidence.

The Fourth Finance Commission had observed that there should be provision for inter-Governmental consultation as there was a wide-spread misunderstanding about the Union Government's policy arising from its alleged tendency to neglect shared revenues and inadequate exploitation of taxes under Article 269. The Sixth Finance Commission was also of the view that a significant improvement in the financial relations between the Union and the States would be achieved if decisions affecting revenues of States were taken after the widest possible measure of consultation as underlying the spirit of Article 274 of the Constitution. A State Government has also suggested that Article 274 be amended to include 'States' besides the 'President' for introducing or moving any Bill or amendment in which States are interested.

The Srinagar conclave of Opposition Parties (October, 1983) had also suggested an institutional forum for consultation between the Union and the State Governments on fiscal issues of mutual concern.
However, neither the State Governments nor the Finance Commissions have dwelt on the organisational details of a forum for regular and formal consultations on financial matters.

In the context of planning relationship, one State Government has suggested a National Planning and Development Council. An eminent economist has suggested setting up of a similar Council, with representation from the States to take care also of their wider interests, for example, in the field of industrial licensing, export and import licensing, subsidies, incentives, employment, etc.

 Evolution of healthy Union-State relations in respect of all financial matters is basic to the proper functioning of a two-tier polity. We have noted that in the Constitution the thorny problem of division of resources between the Union and the States and among the States has been removed from the political arena by providing for a Finance Commission. Transfer of resources for Plan purposes also, to a very large extent, is based on accepted formulae and objective criteria. However, apart from the question of devolution of resources, there is a large area having interface between the Union and the States in respect of financial and economic relations. There is imperative need for organic linkage and coordination between the two levels of Government in raising resources and controlling of expenditure.

 The major areas or matters requiring co-ordinated action may be classified broadly into four groups :
(i) actions of the Union Government which could result in higher resources for the States and also prevent loss of revenues to them;
(ii) restrictions resulting from Union action on taxation by the States;
(iii) actions of Union Government causing increase in States' expenditure obligations; and
(iv) fiscal and monetary policies having a bearing on States' finances.
Group I
(a) Raising resources from heads of taxation covered by Articles 268 and 269 : We have already noted in paragraphs 10.5.13, 10.5.32 and 10.9.26 that the question of raising more revenues from taxes mentioned in these Articles, requires periodic review in consultation with the States.
(b) Revision or rates of royalty : We have considered this matter in detail in the Chapter on Mines and Minerals. We have noted therein the complaint of the States that not only the rates of royalty are low but they are also not revised frequently. The Union Government has pointed out that the States have been imposing large cesses and varying them frequently. This is causing serious problems in ensuring the availability of these basic inputs for economic development at uniform prices throughout the country. Clearly, there is need here for consultation and coordinated action between the Union and the States in this matter.
(c) Policies and administration of Additional Duties of Excise on specified commodities in lieu of Sales Tax : States complain that the Union Government has for long followed a policy of adjusting the basic and Additional Excise Duties in a manner that deprived the States of revenues which they would have realised had the Sales Tax on these items been continued. Recently steps have been taken by the Union Government to enhance these Additional Excise Duties.
(d) Rebates/concessions in Income Tax, Union Excise Duties, etc., where the proceeds are sharable with the States : Much of the misunderstanding that exists in these matters could be cleared if only a measure of prior consultation is resorted to.
Group II
Many measures adopted by the Union Government amount to curbs on States' powers of taxation of purchases or sales. We have noted in paragraph 10.9.02 the complaints of the States in this regard arising from control of the Union over taxation of inter-State trade and commerce and taxation of transactions in respect of essential commodities. Levy of Consignment Tax has been made possible by the Forty-sixth Amendment to the Constitution and this tax is expected to yield substantial additional revenues to the States. We have noted that this power has been vested in the Union to ensure that the free flow of inter-State trade, commerce and intercourse throughout the country is not thwarted and the economic unity of the nation is not endangered by the States by eracting discriminatory or oppressive tax-barriers. Taxation of essential commodities has also to be kept low and reasonably uniform throughout the country.
Group III
(a) Actions of the Union in the field of administered prices of steel, coal, oil, etc., have large implications for the States. These increases affect significantly the costs of various projects undertaken by the States. While in the case of irrigation projects the capital costs go up, in power projects the capital as well as operational costs both escalate.
(b) Upgradation of pay, dearness allowance, pensionary benefits and the like of Union Government employees by its inexorable impact, often leaves the States with no choice but to provide similar benefits to their own employees.
Group IV
One of the most important areas requiring coordination of policies is the field of indirect taxation. The Taxation Enquiry Commission, 1953-54, had observed :
"It is in the field of commodity taxation, however, that the need for understanding and coordination is greatest between the Central Government and the States. The sales taxes, as they have evolved in India, do not consist merely of a tax on the generality of sales, but also include special rates on specific commodities, many of which are subject to taxation by the Central Government in the form of excise duties. There are, besides, questions regarding the use of State sales tax system for purposes of economic policy that may have repercussions on areas and interests outside State jurisdiction".55

We have attempted above to illustrate through certain examples the existence of a vast area requiring inter-governmental coordination of economic policies. As observed by the Taxation Enquiry Commission, with growing importance of public finance in the national economy, and with increasing linking of the Union and the States in the fiscal system, it has become important to develop an integrated, national approach to the problems of mobilisation of resources including taxation and expenditure.

consideration of various financial matters, in the setting of a national perspective is essential to remove any misunderstanding with respect of fiscal measures adopted by the Union and the States as also to evolve mutually accepted policies. Keeping in view the importance of financial relations, it is necessary to provide a forum which will adequately respond to these needs. It is essential that various issues are examined by expert groups from time to time before the same can be brought up for consideration at a political level. This will facilitate crystallisation of issues and indicate possible solutions and remedial actions. We have recommended in the Chapter on Economic and Social Planning that National Economic and Development Council should be constituted under Article 263 as the apex institution for Inter-Governmental consultations on all economic and social developmental policies. Therefore, any forum for discussing financial aspects should be integrated fully into this arrangement.

it is recommended that a Sub-Committee on Finance of the Standing Committee of the NEDC may be constituted consisting of the Union Finance Secretary and the Finance Secretaries of various States and Union Territories. It will consider all such matters calling for coordination of economic policies, as may be entrusted to it by the NEDC or its Standing Committee. This body will report to the Standing Committee of the NEDC. Since Planning Commission would be providing the secretarial support to the NEDC, the same may be extended for this body also. This will ensure expert consideration of various aspects of the problems and adequate consideration of the views of the Union and the State/Union Territories. The role of this Sub-Committee will be deliberative and advisory and helpful in forging a consensus on financial matters.

RECOMMENDATIONS

 Under the present circumstances, duties on all the items covered by Article 268 do not appear to be a buoyant source of revenue amenable to frequent revisions. Since basic circumstances do not always remain constant, the Union Government should, in consultation with the State Governments, periodically consider and explore the revision or imposition of these duties. The revenue raised from these duties should be separately specified in the budget and other relevant publications.

The monetary limit of "Rupees two hundred fifty per annum" fixed 37 years ago on taxes that can be levied on professions, trades, callings and employments (Entry 60 of List II) should be, in consultation with the States, revised upwards immediately and reviewed periodically.

Taxation of agricultrural income is a sensitive matter. Both the Union and the State Governments are not inclined at present for a change in the Constitutional provision in regard to Entry 46 of List II. Many problems have been highlighted by the Union and the State Governments in connection with the levy of such a tax. Nonetheless, in view of its potential, the question of raising resources from this source by forging political consensus and the modalities of levying the tax and collection of proceeds, etc., would require an indepth and comprehensive consideration in the National Economic and Development Council.

By an appropriate amendment of the Constitution, the net proceeds of Corporation Tax may be made permissibly sharable with the States, if and as Parliament may by law so provide. This would have the advantage of enlarging the base of devolution so that in the revenues of the States there would be greater stability and 'redictability, if future. Further, being an elastic resource, the States would benefit from its growth.

The Finance Commission Cell/Division, proposed to be located in the Planning Commission, should continuously monitor the behaviour of States' finances. It should also estimate annually the deviations from the norms evolved by the Finance Commission. The Planning Commission would then be able to bring before the National Economic and Development Council annual reviews indicating, among other things, the deviations from the forecasts of Finance Commission and the reasons for the same. This would afford an opportunity to the National Economic and Development Council to monitor effectively and evolve consensus on the the mobilisation of resources and contain the nondevelopmental expenditure.

The Finance Commission Division should, in cooperation with the States, organise comprehensive studies on trends in growth of public expenditure in the States in the light of the findings of the previous Finance Commission. The studies conducted by the Finance Commission Division should be available well in time for the use of the next Finance Commission.

There is need to further strengthen the Finance Commission Division. It would result in much closer coordination between the Planning Commission and the Finance Commission if this Division were to work under the general supervision of the Member incharge of financial resources in the Planning Commission. Such an arranagement will also make available to the Planning Commission data and analysis on various parameters relevant for resource discussions for the Plan and reviewing of the finances of the Union and the States.

Finance Commission should draw experts for assisting them in their work from various parts of the country. It would be advantageous if suitable experts are drawn from the States also for staffing the Secretariat of the Finance Commission.

A Sub-Committee of Finance of the Standing Committee of NEDC may be constituted consisting of Union Finance Secretary and the Finance Secretaries of various States and Union Territories. It will consider all such matters calling for coordination of economic policies as may be entrusted to it by the NEDC or its Standing Committee. This body will report to the Standing Committee of the NEDC. Since Planning Commission would be providing the secretariat support to the NEDC, the same may be extended for this body also. This will ensure expert consideration of various aspects of the problems and adequate consideration of the views of the Union and the States/Union Territories. The role of this Committee will be deliberative and advisory and helpful in forging a consensus of financial matters.

Treatment of small savings loan is a matter of judgement by the Finance Commission in relation to the over-all debt burden of the States. As long as small savings keep increasing and there is a surplus every year after repayment of due loans, the Union is not called upon to repay any loan not already covered by the net transfer principle. If and when the position changes in any year, when the outgo is greater than the inflow, the States would be responsible for their share of the net small savings collections. If a formula is adopted for such recoupment of revenue from the States, the recommendations of the Finance Commission will be workable. This aspect will have to be examined by the National Economic and Development Council.