What is the issue?

• 15th FC's terms of reference (ToR) is gaining significance with states' demand for more equity and fairness in resource allocation.
• In this context, it is essential to look into the roles and responsibilities of Finance Commission and the ToR of 15th FC.

Why is FC's role so significant?

• Unity - Article 1 of the Constitution of India recognises India as a Union of States.
• Real fairness and equity in the matter of devolution of powers and resources to the States is essential to preserve this stated unity.
• The foremost objective of the FC is thus an equitable distribution of financial resources between the two units of the Union.
• Resources - The fundamental tasks relating to income growth, human development, livelihoods, environment, etc are entrusted to the States.
• At present, the States do not have adequate resources as well as the right to raise such resources to fulfil these tasks.
• FC's role gains significance in equipping states with adequate resources to take up these major tasks of nation-building.
• Federalism - The Centre’s capacity to mobilise resources is far greater than that of the States.
• But states are required to undertake development expenditures that far exceed their revenue generating capabilities.
• The Constitution entrusts FC with the responsibility of addressing this anomaly and asymmetry in India’s federal system.
• Recent developments - The finances of States have received a double blow due to demonetisation, and Goods and Services Tax.
• Post-GST, states have hardly any major tax left with them to make a difference to State resources.

What are the concerns with 15th FC's ToR?

• Demographic differences - From 2001 and 2011 many states have successfully reduced their rate of population growth.
• This does not mean less expenditure for these states.
• These have incurred huge fiscal costs to achieve a lower population growth and healthy demographic indicators.
• They have made substantial investments on education, health and directly on family welfare programmes.
• Moreover it creates new commitments by the States to those in labour force and especially to senior citizens.
• Thus using the population data of 2011 as the base for tax devolution should not reduce the allocation to these States.
• Caring elderly - Many States have achieved a replacement rate of growth of population or have gone below that rate in a short span of time.
• An immediate effect of this is a sharp rise in the proportion of elderly population.
• The enhanced costs for states for caring them must be considered by the FC in allocation and in deciding the population criterion.
• Revenue deficit - It is specified that the 15th FC may also examine whether revenue deficit grants be provided at all.
• Revenue deficits are offshoots of the path of development followed by States.
• It cannot be brought down in the short term.
• To discontinue post-tax devolution of revenue deficit grants would go against the principle of cooperative federalism.
• Approach - The FC should not take a “residual approach” of distributing what is left over after providing for Centre's requirements.
• However, the 15th FC's ToR explicitly privilege the “committed expenditures” of the Centre.
• Policy domain - The 15th FC is asked to consider proposing performance-based incentives.
• This grant is proposed beyond those relating to fiscal responsibility, population and devolution to local bodies.
• States see this as an attempt to micro-manage their fiscal domain.
• This is because states have set their own agenda for development.
• The sectors may include health, education, forest management, public distribution of food, agricultural production, etc.
• This development resulted not necessarily because of Central incentives.
• It was rather the effect of the best practices followed by the states depending on their regional needs and demands.
• Thus, FC proposing “measurable performance-based-incentives” would affect the liberty and flexibility of the states' policy realm.
• It is not the duty of the FC to venture into the realm of day-to-day governance of the states.

• Fiscal space - The 14th FC recommended an increase in devolution to states from 32% to 42%.
• It is argued that the fiscal space available to the Centre had shrunk due to this.
• However, when implementing this, the Union government cut allocations to several Centrally Sponsored Schemes in 2015-16.
• The cutback was almost equal to the amount received by the States as a whole on account of the rise in share of taxes and duties.
• Thus, there is evidently no squeeze of the fiscal space available to the Union government.
• In fact, the total resources devolved from Union to all States put together has been declining as a share of GDP for some years now.
• There is thus no ground for reducing the share of States in the vertical devolution.
• Diversity - To recognise India's diversity is also to recognise the States' diverse paths of development.
• The FC must facilitate diversity and a democratic path of development.
• Respecting principles of equity and fairness in allocating resources between the Centre and States is essential for this.