Fiscally responsible

While the states calculate if they’ve won or lost as as result of the 12th Finance Commission report, the recommendations appear responsible as well as pragmatic since increased funds for states have been provided without unduly straining the finances of the Centre.

The biggest benefits to the states, apart from the additional grants of Rs 82,000 crore (the last Commission gave Rs 58,000 crore whereas this one has given Rs 1,40,000 crore) that the Commission has proposed over a period of five years, are the large savings from the proposal to aggregate all state debt to the Centre and reschedule repayments over a 20-year time frame, at an interest rate of 7.5 per cent (compared to the current 9 per cent).

Since the Centre usually borrows at less than 7 per cent, there is no loss to the Centre.

Hiking the grant element by Rs 82,000 crore will make matters simpler for the Centre since it can now spend money on just a few states for pre-specified objectives, and since this hike is to be linked with getting the states to borrow on their own, it should help impose independent market control over the states’ profligacy.

While Rs 16,000 crore has been provided additionally for education and health in backward states, with some checks to ensure the money is actually spent, this could prove to be an example of the triumph of hope over experience.

Changing weightings for determining the shares of states within the overall tax devolution was a good idea. The changes, however, are not as dramatic as they appear.

While the weighting for a state’s population has been upped from 10 per cent to 25 per cent, this has to be seen in the context of the weighting for poverty being cut from 62.5 per cent to 50 per cent; since the larger states are generally the ones that have more poor people, what they gain on one criterion will largely be neutralised by the other.

Increasing the fiscal performance weighting, from 12.5 to 15 per cent, is a good move, but the numbers suggest caution.

Whether the recommendations work will depend entirely on the finance ministry, including its ability to generate the kind of tax revenues it projects as these are what get distributed to the states.

It is also plausible that once states have more headroom following the debt restructuring, they will go out and borrow more.

While the Commission has linked the restructuring to the enactment of fiscal responsibility legislation in the states, in an extreme case a state can even annul such legislation once the restructuring is done and continue to get the benefits—clearly the ministry needs to give the recommendations some teeth.

The larger problem remains, that finance commissions project normative expenditure/revenue for states and then fill the gap with more transfers/grants.

Since there is no permanent secretariat for finance commissions, such calculations of a state’s expenditure capacity and revenue-earning capability are made afresh each time round, usually with a light hand on the reins, and tend therefore to have an element of arbitrariness.

This is an issue that concerns all finance commissions.