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An Appraisal of the Existing Framework of Centre-State Relations

The Constitutional scheme of governance at the Centre and in the States is provided in Part Xl (Articles 245 to 263), and Part Xl (Articles 264 to 298), with few related provisions on trade and Commerce in Part XI II and on all India Services in Part XIV. Broadly it deals with three types of relations namely (a) Legislative Relations (Articles 245-255); (b) Administrative Relations (Articles 256-263); and (c) Financial Relations (Articles 264-293). The Report is prepared following this scheme and analyzing the issues and challenges under each of the three types of Centre-State relations.

The Scheme on legislative relations is largely based on the federal principle of “subsidiary” under which what can best be administered from the Conger are kept with the Union (Union List.) and those which are more of regional or local interest are assigned to the Units (State List:) with some items at-common concern in what is called in the Concurrent list. fart XI distributes the legislative powers between the Union and the States. The subject-matter of legislation are -listed rather exhaustively in the. three Lists given in the Seventh Schedule. Constitution gives autonomy to Centre and States within their respective fields. Parliament may make laws for the whole or any part of the territory of India and the State Legislature for the whole or any part of that State. However, applying the doctrine of territorial nexus, State laws having extra-territorial operation have been held valid by the court. There are several judicial doctrines evolved by the Supreme Court to interpret possible overlapping off jurisdictions in the matter of legislative powers of Centre and States. By and large the scheme worked reasonably well, though States have complained about the Union transferring; items from the State list to the Concurrent list without adequate consultation.

In the event of a conflict between a Union law or State law, Article 250 stipulates that the Union law will prevail irrespective of whether the Union law is enacted prior to the State law or subseyuent to the State law. This means in effect that Parliament can repeal a State law at any time with respect to a matter in the Concurrent List, even if made with consent of President. Parliamentary supremacy in matters falling under List I and III is secured by the Constitution. Furthermore residuary powers of legislation is exclusively with the Union (Article 248).

The supremacy of the Union in legislative matters is further clear from the extent of powers the Union enjoys to legislate on subjects in the State List under certain circumstances. These include:

1. Power of Parliament to legislate in national interest under a Resolution of the Upper House (Article 249) .

2. Power of Parliament to legislate during operation of Emergency (Article 250)

3. Parliaments power to legislate with the consent of States (Article 252)

4. Legislation for giving effect to international treaties and agreements (Article 253)

5. Power to legislate in case of failure of Constitutional machinery in States (Article 356)

Again, another issue in respect of legislative relations which caused friction between Centre and States is the power of Governor to reserve any Bill passed by the State Assembly for consideration of the President, sometimes for an indefinite period! A law adopted, sometimes more-than once, by the Assembly can -therefore become a- law in the State only if assented by the President (Articles 2.111, 201).

It is more in the sphere of administrative relations; the scheme was put to test on several occasions. The scheme is aimed-to facilitate implementation of Union laws in States, achieving co-ordination for administrative efficiency, resolving disputes when they arise and to ensure that the Union intervenes whenever a State is threatened by external aggression or internal disturbance.

The division of executive power is co extensive with the, division of legislative Power -of both the Governments (Article 7 3 and 162)

The issue of Centre-State co-ordination in administrative matters has been a complex issue though the Constitution did provide some mechanism s. For example, by agreement or legislation (Article 25$) delegation of administrative powers is provided for. Greater inter-state co-ordination is also sought to be achieved through All India Services the control on which vests jointly on Union and States

Article 257(1) says that the executive power of the State shall be so exercised as not to impede or prejudice the exercise of executive power of the Union. The Centre is empowered to give directions to States in this regard. If directions are not complied, emergency provisions may be invoked by the Centre. The Constitution thus provides a coercive sanction against any disobedience of the Central directions by the States.

On conflict resolution outside courts, the Constitution envisaged some administrative and quasi-judicial arrangements which seem to have made little impact in smoothening relations. Article 263 provides for an Inter-State Council which was invoked only in 1990 after the Sarkaria Commission recommended the same. It is supposed to be a body for intergovernmental consultation and co-operation. It is to inquire and advise on disputes between States, investigate and discuss subjects of common interest and make recommendations on any subject for better co-ordination and action. It, however, meets rarely and has not been able to work to its full potential.

The other body for conflict management i what is provided for in Article 262 for the resolution of inter-state water disputes which also failed to contain mane disputes which reached it despite repeated hearings and decisions.

In-short, the survey of existing arrangements on administrative relations leaves one to wonder whether there are gaps and inadequacies in the matter of administrative co-ordination and conflict management. Informal methods outside the Constitutional scheme are often pressed into service to keep governance going despite the shortcomings. .

Another- issue which opened up a set of administrative problems is about the role of Centre in accomplishing effective decentralization under the 73rd and 74th Amendments to the Constitution. The States which are supposed to make law in this regard have been sloe- in the matter of empowering Panchayats with functions, funds and functionaries. Meanwhile through Court interventions and Otherwise, Panchayats have elected representatives who are not able to organize governance at local levels as expected. There is a feeling that the existing arrangements need a fresh look to put the third level of governance back on rails to make democracy function.

The scheme of financial relations is another vexed issue which, inspire of the elaborate provisions on division of taxing powers and the intervention of the mechanism of the five-yearly Finance Commission, continue to be a friction point in Centre-State relations. The scheme contemplates complete separation of taxing powers between the Union and the States, mechanism for sharing-of revenue, and a system of grants-in-aid to bridge gap between fiscal capacity for administration and for making intergovernmental financial adjustments.

While the taxes levied by the States are collected by them and entirely go to their Consolidated Fund, the taxes levied by the Centre arc sharable with the States.

The distribution of revenues raised by Union is regulated through assignment, compulsion, sharing, permissible sharing and grants-in-aid (Articles 268-281).

The method usually adopted to adjust the imbalances between the functions and financial resources of the two layers of governments in a federal system is the transfer of funds from Union to States. While safeguarding the autonomy and stability of State Governments, the scheme of financial devolution must bring about financial equalization with a sense of fiscal responsibility and promote the welfare of the country as a whole. A purely discretionary system is unacceptable in a federal framework. Therefore an independent agency like the Finance Commission is proposed to assess the changing needs of the States and imbalances between the richer and poorer States.

The borrowing powers of the Central-and-State Governments are regulated by-Articles 292 and 293 under which States can borrow from sources outside India -only with the prior consent of the Government of India.

In the division of taxing power, generally speaking, taxes that have an inter-state base are under the legislative jurisdiction of the Union, while those that have a local base (land, agricultural income etc.) fall under the legislative jurisdiction of the States.

Concluding Remarks

A remarkable feature of the Indian federal scheme is its capacity to give expression to regional, linguistic fund other sub-national identities of vast sections of Indian humanity. Re-organization of states, breaking up of larger states and creation of more number of smaller ones, introduction of a third-tier of governance in the form of Panchayats and municipalities are examples of the deepening of the regional and local structures of democratic governance. Rule. of law and guaranteed rights of individuals also helped to articulate and re-inforce the multiple identities that make the Republic of India.

However, the process of this massive social and political transformation has not been without hiccups and turmoil. Sub-national identities were strengthened by political parties floated around them and seeking to influence governmental decision-making. If in the first General Election India had only 14 national parties and two dozen regional parties, today the number of parties has grown to Over 250 of which only half a dozen are named national parties. One of the direct consequences of this development is the emergence of unholy coalitions in government formation and unprincipled divisional and defections affecting political Stability and good governance. Local power cities, sometimes formed on caste and class considerations, have managed to capture power and influenced policies not always primitive of the Constitutional purpose. While democracy has taken deep roots, development has suffered in pace and direction. Economic liberalization however has led to some degree of integration of the market and a new cohesion cutting across political divisions and regional sentiments.

An interesting by-product of these political and economic developments is an increasingly stressful relationship between the Union and-the States as-well as states inter-se. The strong centre concept advanced by the Constitution makers came under challenge particularly vis-a-vis fiscal arrangements and financial devolution. Significant transfers taking place through channels and mechanisms designed by the Union and not envisaged by the Constution angered the States. The way the Union exercised emergency provisions ryas successfully challenged in die Courts and powers got circumscribed. The role of the Governor and the process -of implementation-of decentralized governance came in for criticism and occasional conflicts- These could have been effectively mediated through political processes in the Legislative assemblies and parliament. Unfortunately, the credibility of legislatures evolving compromises through Consultation and debates has declined of the years and issues were-taken to the streets of- the Courts straining Centre-State relations and weakening governance. Rule of law was disturbed on many occasions and the institutional mechanisms for conflict resolution outside the judiciary have been found wanting to smoothen relationships.

India today presents the picture of a functioning democracy performing, reasonably well in economic development but unable to sustain good governance for the welfare of all people, particularly the weak and marginalized sections. The Union in theory continues to be’ strong in Constitutional terms; but in practice it is unable to deliver the way it could have clone. The States have become strong not so much in governance but in politics and power play. The Panchayats remain weak despite all good intentions. In this milieu, Centre-State relations present a mixed picture of promise and performance far from its full potential.

ISSUES IN CENTRE-STATE FISCAL RELATIONS

Background

In this chapter, we have identified some important and contentious issues raised by States and other stakeholders and issues which have come to the fore following economic liberalisation and other policy changes in the area of Centre-State fiscal rela­tions. Issues relating to the role of the Finance Commission and the Planning Commis­sion are discussed separately in the relevant chapters of this volume

Vertical Imbalance in Resource Sharing

The States have been nursing a feeling that the resource transfers to them have not been commensurate with their growing responsibilities In a common memoran­dum submitted to the Thirteenth Finance Commission (FC-XIII) and in response to our questionnaire, States have demanded an increase in their share of Central taxes from 29.5 per cent to 50 per cent. We have observed in Chapter-4 that the relative shares of the, Centre and the States in combined revenue receipts have remained stable before and after Central transfers. The focus of the Eleventh Five-Year -Plan (2007-12) is on the achievement of inclusive growths most areas contributing to a broad based growth like agriculture, education,- skill development provision of health services, welfare of weaker sections, etc., are in the realm of States, there is a clear need to realign the resources in favour of States. There are clear advantages in empowering the States fiscally. As the Sixth Finance Commission (FC-VI) observed, When the- emphasis is on social justice, there is no escape from realignment of resources in favour of States, because services and programmes which are at the core of a more equitable social order come within the purview of the States under the Constitution’. Since the period covered by FC-VI, there has been a further shift in expenditure in favour of the social sectors adding to the expen­diture commitments of States.

Growing Central Expenditure on Functions in the State List

FC-X1.1 estimated that a fifth of the expenditure incurred by the Centre was on subjects, which were in the domain of the States‘. With the introduction of new Central Plan Schemes and new CSS, this proportion would have gone up considerably since the submission of the Report of FC-Xll. A number of developments have resulted in increasing Central expenditure on State subjects. These are increasing discretionary transfers in the form of assistance for CSS, special plan assistance and special Central assistance. Growing discretionary transfers from the Centre have severely constrained the States in drawing and implementing schemes according to their priorities and the felt needs of people. Since our mandate is vast, we cannot look into the composition of all transfers to States. We are, however, convinced about the need for a detailed review- of all transfers to States. We, therefore, recommend a comprehensive review of all transfers to States with a view to minimizing the component of discretionary -transfers, particularly those channeled through CSS.

Regional Imbalances

Growing regional imbalances both inter-State and intro-State are matters of serious concern and are counter to the objective of realising the goal of inclusive growth. The strategy consisting of area specific programmes and the area specific tax exemptions have so far failed to address the problem adequately. A number of Committees have gone into the issues relating to growing imbalances in regional development and made recom­mendations to address these issues. The National Committee on Development of Backward Areas . Sivaraman Committee drew attention to the large variations in climate, rainfall, topography and soil conditions across the underdeveloped regions and called for a differential approach to address the problems confronting them. The Committee also observed that special area development programmes were more in the nature of palliatives that failed to tackle the root of the problem and that most of the backward regions had potential for growth which could be tapped of certain special initiatives were taken. The Committee recommended that it• should be the task of planning to identify the special. Initiatives suited to each backward region”. The Eleventh Plan document observed that redressing regional disparities is not only a goal in itself but crucial for maintaining the integrated social and economic fabric of the country without which the country may be faced with a situation of discontent, anarchy and breakdown of law and order.

A large part of the population lives in the less developed-regions in the country resulting in increased migration with its resultant consequences. With public investment constituting less than 20 per cent of aggregate investment in the country, there should be a paradigm shift in the role of the States from being undertaking direct invest­ments to that of facilitating investments in backward regions. This calls for States to improve infrastructures facilities - both physical and human. As the resources at the com­mand of the States are limited, we recommend higher central transfers to backward States to enable them to improve their physical and human infrastructure.

It is generally observed that there is an emphasis on taking up new prograrmmes for the development of the backward regions of the country to the neglect of the main­tenance of assets created under earlier plan schemes. To realize the benefits of past investments in backward regions of the country, we recommend that maintenance of assets already created should form an integral part of planning in these regions.

As the problems facing the backward regions are multi-dimensional, there is a need for a multi-pronged strategy to address the problem of regional imbalances. We recommend the adoption of a multi-pronged strategy in the backward regions of the country comprising public investment in infrastructure development, pro-active policies to attract private investment, higher public expenditure on social sectors, such as health and education-and area specific strategy for the growth of agricultural production.

Poor quality of governance and service delivery characterize most backward States. These act as deterrents to private investments. Full benefits of public-investment will not be realized in the absence of good governance. We recommend that there should be greater focus on the issues of governance in the less developed States of the country.

Access to banking services and institutional finance is crucial for financial inclusion. Regional spread: of banking assumes importance in this context. The average population served by a bank branch at the end of July.. 2009 was 25,000 in Bihar and 18,000 in Jharkhand as compared with the all-India average of 15,000. In most north­eastern Stares, the average population served by a bank branch is much higher than -the national average. In most backward States, the Credit-Deposit Ratio (D ratio) of commercial banks is much lower in relation to other States. The C-D ratio as per sanction at the end of July 2009, was 37.0 in Bihar, 40.2 in Jharkhand and 52.5 in north-eastern States as compared with the ratio of 96.1 in southern States and the all-India average of 80.2‘. This Commission is concerned about the low C-D ratio in the backward States. Suitable policy initiatives should be taken to improve the C-D ratio of bank credit in the poorer States in a time-bound noted manner. Efforts should also be made to spread the habit of banking among the poorer sections of society to achieve the objective of financial inclusion.

Compliance and Enforcement Cost of Central Legislation

There are a number of Central legislations, the compliance and enforcement cost of which are entirely borne by the States. Central Legislations, such as, the Environ­ment Protection Act, the Wildlife Protection Act, the Forest Conservation Act, the Biodiversity Conservation Act, the Tribal Conservation Act. and many other national policies require compliance on the part of States. At present, States are not compensated for the cost of compliance and the revenue loss on account of compliance.

Recently, the Government of India has taken a number of initiatives to build a structure of legally enforceable rights and entitlements to ensure uniform service delivery across States and to ensure accountability on-the part of the Government at all the levels. Provision of free education and food security are some of the areas where the legislative process has already been initiated. The Right of Children to Free and Compulsory Education (RTE) Act, 2009 has mandated provision of free and compulsory educa­tion to all the children in the age group of 6 to 14 years. The Act also contains provisions relating to the responsibilities of the Central Government, Stare Governments and local authorities. The Central Government is entrusted with the responsibility of creating a national curriculum, developing and enforcing teacher training standards -and providing State Governments with technical assistance for innovation, research and capacity build­ing. The main responsibilities assigned to State Governments and the local authorities are provision of free and Compulsory education for the children in the age group of 6-14 years, ensuring compulsory admission, providing for the availability of, neighboring schools, preventing discrimination of children from weaker sections, provision- of infra­structure facilities and maintaining quality of education.

The RTE Act Mandates the Central government to provide grants-in-aid to States towards meeting a percentage of expenditure as may be determined from time to time in consultation with the States. Under section 7(4) of the RTI Act, the Central Government may make a request to the President to make a reference to the Finance Commission to examine the need for additional resources to be provided to any State Government so that the said State Government may be provided its share of funds for carrying our the provisions of the Act. The RTE Act has broken new ground in clearly delineating the functional and financial responsibilities of the Central and State Government. There is no such clear delineation of financial responsibilities in other Central legislations, where the States are entrusted with their implementation. We recommend that all future Central legislations. should provide for cost sharing as in the case of the RTE Act. Existing Central legislations where the States are entrusted with the responsibility of implementation should be suitably amended providing for sharing of costs by the Central Government.

The Government has announced its commitment to enact legislation provid­ing food security to the poor. Under the proposed legislation, families below the poverty line will be entitled to a prescribed quantity of food grains every month. The proposed legislations will impose additional costs on the State Governments. We recommend that the proposed enactment should clearly delineate the responsibilities of the Central and State Government in meeting the additional cost of implementing the provisions of the Act.

Extraction of minerals involves huge costs in terms of environmental pro­tection and rehabilitation of people. At present these costs are borne mainly by the States and only partly by the leaseholders. As the extraction of mineral wealth serves national interests, costs of environmental protection and rehabilitation cannot be left entirely to the mineral bearing States. The Government of India also derives substantial revenue from export duties on minerals. In Volume VI of out report, we have recommended a mechanism to compensate the mineral bearing States.

Central legislations/Administrative instructions also impose additional costs on the Statws. These mainly relate to (a) Schemes of Central Government like Sarva Siksha Abhiyan (SSA); (b) Climate Change and Environment Management; (c) Judicial work resulting in increased case load on the courts; and (d) fulfillment of international treaty obligations entered into by the Central Government. It is the considered view of this Commission that: the additional expenditure liabilities on States on the above counts should be suitably compensated for which a mechanism needs to be institutionalised. The Commission feels that this purpose would be best served by incorporating the issues giving rise to such liabilities as a part of the permanent Terms of Reference of the Finance Commissions. .

Impact of Pay Revision by the Central Government on State Finances

The periodic pay revision by the Central Government gives rise to demand on the part of State government employees for a similar pay hike. For the States, it is a demand which is difficult to resist. Following the implementation of the recommendations of the Sixth Central Pay Commission (SPC), a number of States have revised their pay scales and others are in the process of doing, so. Some States have simply adopted the pay scales recommended by the SCPC. FC-Xlll has estimated that the additional cost of pay revision is likely to be asymmetrical as between the Centre and the States. FC-XIII has concluded that the additional liability on account of pay revision will be much higher for States than for the Centre taking into account the additional income tax revenue that accrues to the Centre following higher salary payment’.

In a common memorandum submitted to FC-XIII, States have demanded that the Central Government should bear at least 50 per cent of the additional consequential burden, following the pay revision in the: case off general category States and 100 per cent of the additional burden in the case of special category States’”. A similar demand was contained in the response of States to our questionnaire. As an alternative, the common memorandum urged the Finance Commission to take full consideration of the States’ expenditure on civil administration and committed expenditure including the additional burden of pay revision. The memorandum further contended that the enhanced income - tax revenue-to the Centre consequent upon the pay revision fully justifies such a demand. We. recommend that the ToR of future Finance Commissions should be formulated in such a way that the additional commitments of States on account of pay revision arc fully taken into account.

Revision of Royalty Rates on Major Minerals

At present, the. power to Fix royalty on major minerals is vested with the Central Government- Under the provisions of the Mines and Minerals (Development and Regulation) Act 1957, the -Central Government shall not enhance the royalty in respect of any mineral more than once during any period of three years. One of the main grievances of the States is that the provision of revision of-royalty rates is not being adhered to and that there arc undue delays in the revision of these rates at. periodic intervals depriving the States off potential revenue. The rates of royalty were revised in August. 2009 after an interval of nearly five years. The delay, was not justified as an Expert Committee (Hoda Committee) had recommended the pattern on which these were to he revised. Another issue is the conversion of specific rates of royalties into ad valarem rates based on mineral prices. The revision of royalty rates effected in 201)9 addressed the concerns of the States partly with regard to the conversion of specific rates into ad rala­rem rates on certain minerals. In August 2009, rates of royalty on amphibole asbestos, china clay, graphite, iron ore, quartz., silica sand, moulding sand and quartzite were shifted from tonnage to ad volorem basis. The Sarkaria Commission had recommended revision of royalty rates at an interval of every two years. We are of the opinion that the royalty rates should be revised at least every three years without any delay. States should be properly compensated for any delay in the revision of royalty beyond three years. In Volume VI of our Report, we have recommended a mechanism for the periodic revision of royalty rates.

Sharing of Off-Shore Royalty and Sale Proceeds of Spectrum

5.8.01 With the increased exploitation of offshore oil and gas reserves, the non-tax revenues of the Centre are likely to improve considerably through higher royalty collections. Under the present Constitutional arrangements, offshore royalty accrues entirely to the Centre. There is a case for reviewing the present arrangement and giving a share of the offshore royalty to States. Similarly, substantial revenue is likely to accrue to the Centre through the sale of 3G spectrum. The realization from the sale of spectrum mainly depends on the market for telecom and related services available in a State/Circle•, which in turn depends on the infrastructure for business development and an enabling environment. States are largey responsible for the development of infrastructure and creating an enabling environment for the industry and business. We recommend that a part of the sale proceeds of spectrum should be devolved to States for expenditure on infrastructure projects.

Service Tax

Service tax is being levied since 1994 by the Centre under its residual powers relating to subjects that are not specified in any of three lists in the Seventh Schedule to the Constitution. With the 88th Amendment of the Constitution, service tax was brought under the purview of Article 268 A (3) under the Union List. Article 268 provides that taxes on services shall be levied by the Government of India and such tax can be col­lected and appropriated by the Government of India and the States. The Article further provides that the principles of levy and appropriation shall he determined by Parliament. Till now the sharing of the service tax is on the basis of the recommendations of the Finance Commissions. Once the Constitutional amendment is notified, taxes under Ar­ticle 268 A would be excluded from the purview of the Finance Commission

FC-II observed that the exclusion of the proceeds of service tax from the purview of the Finance Commission would amount to reversing the pooling of all Cen­tral taxes facilitated by the 80th Amendment of the Constitution- With the proposed introduction of CST, service tax will be subsumed under the GST Therefore, it is un­likely that the 88th Amendment would be notified. FC-XII recommended that any, legislation passed by Parliament-with respect to appropriation of service tax proceeds should ensure that the revenue accruing to the States through any proposed changes should not be less than the share that would accrue to them, had the entire tax proceeds been part of the divisible pool. We endorse fully the recommendation of ‘FC-XII with regard to the sharing of service tax in the event of the notification of the 88th Amendment to the Constitution.

In response to our questionnaire, a number of States and other stakeholders favoured vesting the States with the power to levy service tax. Conferring such powers on States will need a Constitutional amendment. With the proposed introduction of GST within the next one or two years, States will have concurrent power to tax services. We, therefore, do not see any need to change the status quote in the interim period

Profession Tax

Under Article 276 (2), tax on professions, trades, callings and employments shall not exceed Rs. 2, 500 -per annum. The limit was raised to Rs. 2,500 by a Constitu­tional amendment in 1988 -from Rs. 250. The Sarkaria Commission recommended raising of the then existing limit of profession tax. As income and salary levels are increasing, a limit on the profession tax constraints revenue mobilizations. In most Status, procceds from profession tax are devolved to the local bodies. There is a consensus on the need to empower local bodies in terms of financial resources to enable them to discharge their responsibilities. We recommend that the current ceiling on profession tax Should be completely done away with by a Constitutional .amendment.

Taxes under Articles 268 and 269

States have been a nursing a grievance & that the Centre has not been exploiting the revenue potential of taxes listed under Articles 268 and 269. The duties mentioned in Article 268 relate to stamp duties and duties of excise on medicinal and toilet preparations. Service tax was included in this Article by the 88’t’ Amendment Examina­tion of the scope of taxes under Article 268 was referred to FC-VIII. The. Commission expressed the view that there -was scope for raising the rates of duties in respect of bill of lading, letters of credit and the policies of general insurance”. As regards duties of excise on medicinal and toilet preparations, the Commission indicated that it did not haye data to suggest specific increases in the rates.

Under Article 269, duties in respect of succession to property other than agricultural land, estate duty, terminal taxes on gods or passengers carried by railway; sea or air, taxes on railway fares and frights, taxes other than stamp duties on transactions in stock exchanges and futures markets, taxes on the sale and purchase of newspapers and on advertisements published therein, Central Sales Tax (CST) and consignment tax were leviable and collectable by the Centre but assigned to States. Of these., only two taxes, namely, estate- duty and CST were being levied. With the 88" Amendment to the Constitution, the list of taxes leviable under Article 269 has been reduced to CST and consignment tax, of which the latter is not levied. The rate of (.ST was reduced from 4 per cent to 2 per cent and is likely to stand abolished once GST is introduced. -

The scope for raising more revenue from taxes under Article 269 is now al­most non-existent with the reduction in the number of taxes leviable and the imminent abolition of CST. The scope to raising more resources from the taxes mentioned in Articles 268 and 269 was last examined by FC-VIII more than 20 years ago. We, there­fore, recommend that the scope for raising more revenue from the taxes mentioned in Article 268 should be examined afresh. This issue may be either referred to the next Finance Commission or an expert Committee be appointed to look into the matter.

FRBM Legislation

Following the incentives under the Debt Consolidation and Relief Facility recommended by FC lll, all the-States with the exception of West Bengal and Sikkim had enacted fiscal responsibility legislations. We consider it as a game changing; development­ ushering in an era of rule based management of public finances. The all round improvement in public finances in the post-FRBMA era is evidence enough as to the effectiveness of such legislation. At the time of the formulation of the Eleventh Plan, there was considerable debate on the need to relax FRBMA targets to enhance public investment. The Approach Paper to the 11th Five-Year Plan hinted that the first two years of the Plan could be vulnerable because of the possibility of a cyclical downturn, oil price hike and lack of flexibility in the FRlBNA. The Paper further stated that there was a need to review the targets under the FRBMA, particularly those relating to the elimina­tion of revenue deficit because of the shift in Plan expenditure towards social sectors. The Paper observed that internationally, FRBM legislations only focused on fiscal and primary deficits as targets. The Paper called for redefining approach to FRBM to conform to international position in the long run’.

We feel that the ballooning of revenue deficits was the root cause of fiscal deterioration observed in the nineties. We are, therefore, not in favour of doing away with the target of revenue deficit elimination in the FRBM legislatione. At present, the deficit reduction targets are uniform across all States. This ‘one-size fits all’ approach has constrained fiscally strong States to raise more resources. We, therefore, recommend State­specific targets of fiscal deficit. The fiscal correction path may factor in the variations in the initial fiscal situation across States and be made State-specific.

The targets under the FRBMA can be adhered to either by revenue augmen­tation or expenditure compression The fiscal correction achieved -in-the post-FRBM. pe­riod was mostly through revenue augmentation and partly through revenue compression. It is a matter of concern that in years of fiscal stress,-there is a tendency to cut dowry capital expenditure. At the level of the Central Government, capital expenditure-wit­nessed a decline from 22.86 per cent of total expenditure in 20)4-05. to 12.35 per .cent of total expenditure in 2008-09. in the case of the States, capital expenditure declined from 28 per cent of the total expenditure in 2004-05 to 2, per cent in 2007-08.. Thus, with overall targets for revenue and fiscal deficit reduction under the FRBMA, there is a ten­dency to adhere to targets by compressing productive expenditure, thus defeating the vet purpose: of such legislation. It is, therefore, necessary that duality of fiscal adjust­ment is built into the FRBMA targets-. We recommend specification of targets with regard to maintaining certain levels of expenditure on social services, maintenance and creation of capital assets in the FRBMA legislation.

One of the methods of circumventing the FRBM targets is through off-budget liabilities.-The Government of India has-been issuing bonds to oil marketing and fertilizer companies which are oft-budget and do not add to the fiscal deficit. But these are nevertheless liabilities of -the Central Government. It is therefore .necessary to bring all the off-budget liabilities of both the Central and State Governments into fiscal ac­counting. In addition changes in accounting; practices also make is easier to adhere to FRBM targets. Termination of onlending to States from 2005-06 has considerably re­duced the fiscal deficit of the Central Government. With a view to deriving the full benefits of FRBMA we recommend bringing all off-budget liabilities into fiscal account­ing. Suitable adjustments should be made for changes in accounting practices if any.

At present under the FRBMA targets of deficit reduction can be exceeded in the event of unforeseen circumstances. In the event of non- adherence: to the targets the Union Finance Minister/State Finance Minister is required a make a statement in Parlia­ment/State Assembly detailing the circumstances leading to the non-adherence to targets and the steps proposed to be taken to adhere to the targets. Thus, there are no effective deterrents preventing the Centre or the States from deviating from the fiscal correction path set out in the FRBMA. We recommend that the FRBMA should be amended to clearly specify- the circumstances which should warrant deviation from the targets.

Some of -the State fiscal responsibility legislations provide for an indepen­dent evaluation of adherence to the legislation. In most cases this has not been operationalised. The Central Legislation does not provide for an independent evaluation. To bring greater accountability all fiscal Iegislations should provide for an annual assess­ment by an independent body and the reports of these bodies should be laid in both Houses of Parliament/State Legislature.

Market Borrowings

Under Article 293 of the Constitution, State Governments require the ap­proval of the Centre for borrowing from the market, if then are indebted to the Centre. The Centre has been setting the limits on thee market borrowings of States as part of the overall pattern of plan financing. States have been complaining from time-to-time that their share in overall market borrowings- has cone down significantly. In the car 2008­09, the shares of the Centre and the States in the aggregate market borrowings were 25 and 75 per cent, respectively. In their common memorandum submitted to FC-Xlll, States­ have contended that their share in market borrowings should be restored to the level of 50 per cent ac was prevalent in the fifties. We were also urged to recommend such an increase in the share of the States.

With the enactment of FRBM legislations by the Centre and the States, over­all borrowing limits for each year are fixed taking into account the fiscal deficit target for the year and the fiscal correction path recommended by FC-Xll. A prescribed share in market borrowings for States has lost much of its relevance in the post-FRBM regime. It is necessary that the present system of timing overall borrowing Limits is continued to ensure adherence to FRBM targets.

Small Saving Loans

As Indicated in Para. 3.8.02, the mandatory Sharing-Of net small saving collections in the form of loans from the NSSF by the States was reduced from 100 per cent to 80 per cent from 2007-08. Though the mandatory sharing is set at 80 per cent, States are given the option of borrowing from the NSSF to the extent of 100 per cent of net collections in a year. Loans from the NSSF carry an interest rate of 9.5 per cent per annum, which is perceived by States to be very high in relation to the cost of raising small savings by the Centre. Another grievance of the States is that with the transfer of small saving collections to the NSSF from 1999-2000, loans from the. NSSF are no more treated as loans from the Centre depriving them of the facility of relief offered on outstanding debt to the Centre by the successive Finance Commissions. In their responses, States have demanded that the Finance Commissions should take into account their entire loan burden, including the outstanding loans front the NSSF.

A number of committees have gone in to the question of administration of­ NSSF One of the important recommendations of these committees was the linking of interest rate on loans from NSSF to the interest rate on Government securities. We en­dorse this and recommend that interest relief may be altered on loans from the NSSF by aligning the interest rate on loans from the NSSF to the rate of-interest on Government securities. The present repayment period of 25 years relay -continue.

Direct Transfers to Local Bodies and Implementing Agencies

5.15.01 Over the years, a number of district level agencies have been created for the implementation of CSS. The Central Ministries are directly transferring substantial amounts of money to these implementing agencies in Stages bypassing the State Governments. This has considerably eroded accountability and undermined the role of States. In the Central Budget for 2009-10, an amount of Rs. 95,567 crore is budgeted to be passed on directly to inlplernenting agencies. This system put in place ostensibly to address the problem of delays (III the part of the State Governments in releasing funds to impletlementing agencies has given rise to a number of problems. It has eroded accountability. I arge sums are. reportedly lying unspent in the bank accounts maintained by the implementing agencies. There is no proper accounting of these funds. lmplenlenting agencies are part of the State Government but are not accountable to it. We arc of the opinion that direct transfers to implementing; agencies should be stopped. It should be ensured that the State Governments pay interest in case of delays in the transfer of funds beyond 15 days of their receipt front the Central Ministries. We have dealt with this issue further in Volume of our Report on Local Bodies.

Macroeconomics Stabilisation

5.16.01 Macroeconomic management is the responsibility of the Union Government as per the Constitution of India. In the wake of the countercyclical measures initiated to neutralise the impact of the global downturn in the last two rears, the Centre has raised fiscal deficit targets of States to 3.5 per cent of GSDP in 2008-09 and further to 40 per cent of GSDP in 2009-10 and accordingly raised the market borrowing limits of States. The proposal to include aviation turbine fuel in the list of declared goods was under the consideration of the Central Government to help the ailing airline industry in the country. Such a measure would have reduced revenue from VAT by the States. It was reported that the Government of India had put on hold the decision relating to the revision of royalty rates on major minerals as well as the conversion of rates into ad Valanrem system in the interest of maintaining price stability (Economic Times, June 4, 20(18). WC are of the view that the maintenance of macroeconomic stability is the responsibility the Union and that States should be properly compensated for any additional expenditure the bear or revenue loss they suffer on account of measures taken by the Union to maintain macroeconomic stability.

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