Prime minister Narendra Modi may have promised to give states more autonomy when it comes to their spending priorities, and even disbanded the Planning Commission that is a vestige of centralised planning, but his government has asked the Finance Commission not to increase the share of central taxes that are devolved to states automatically.
In its pitch to the Finance Commission last fortnight, the finance ministry said it didn’t have the requisite fiscal space due to defence and other spending — including the need to hike GST compensation to states — so the devolution share should be kept at the current level of 32% for the next five year period beginning FY16. Within this, transfers to individual states are based on their population and land area and backwardness among other factors. The centre also has to grapple with more demands from Andhra Pradesh (thanks to the creation of Telengana) as well as various states like Bihar that are asking for more funds.
The Finance Commission report will be submitted next month—all states have already made their requests, several have asked that the ratio be raised to over 50%.
Of the total transfers from the centre to the states, around half comes by way of their share in central taxes and an equal amount by way of grants and loans for the Plans of various states as well as the plethora of centrally sponsored schemes. In the FY15 budget, a total of R 7.8 lakh crore is to be transferred to states, and R3.8 lakh crore of this is to come by way of automatic sharing of central taxes.
If states have to be freed from the yoke of central ministries telling them where to spend their money — on irrigation or roads — the only way to do this is by way of raising the automatic devolution tax share.
Besides creating a formula for transfer of tax proceeds and grants to states during the five years beginning FY16, the 14th Finance Commission's terms of reference also include laying new fiscal consolidation road map, suggesting a mechanism to compensate states for any revenue loss for them due to the implementation of the Goods and Services Tax (GST).
The fiscal flows from Centre to states are governed by Article 280 of the Constitution and these have conventionally been governed by the (fixed) formulas prescribed by the Finance Commissions (and approved by the Centre) for five year periods, giving little flexibility for the Centre to deviate from them. In the case of the centre's aids to state Plans, however, a lot of discretion is practically being enjoyed by the Centre (through the Planning Commission) although the allocations are made after consultations with states.
Between FY01 and FY13, apart from the obvious weavers’ and Bundelkhand-type packages, for instance, the ultra discretionary Special Plan Assistance and Special Central Assistance have risen from 5.9% of central assistance to state Plans to 16.5%.
Freedom on hold
States get 32% of all central tax collections today. Several asked Finance Commission to raise this to over 50%
Of every R100 states get from Centre, around R50 is from automatic tax transfers based on the 32% formula
The rest comes from plans run by various ministries. Many BJP chief ministers have called this ‘tied aid’
Govt cites commitments like GST compensation and defence spending to argue against hiking 32% limit