(Sample Material) Gist of Important Articles from IIPA Journal

Topic: Indian Finance Commission G. Thimmaiah

Promoting National Welfare Complementing Planning Commission

The methodology is intended to minimize vertical as well as horizontal federal fiscal imbalances and to enable the future Finance Commissions to function smoothly side by side with the Planning Commission. In India, this is necessary to make the functioning of Planning Commission effective. A major objective of my suggested methodology is, therefore, to make the Finance Commission complement the role of the Planning Commission in the task of promoting national welfare. The Planning Commission should continue to recommend the distribution of plan grants under Article 282 in accordance with its responsibility for formulating the national economic plans which embrace all the states’ plans. The responsibility of distributing plan grants provides the Planning Commission with an effective control over the states’ plans and priorities as they have to be coordinated with those of the national plan. Further, as the Fifth Finance Commission recognised, the Planning Commission also recommends additional Central assistance to states in case of severe financial difficulties during the interval between the two Finance Commissions. Therefore, the Finance Commissions should recommend tax shares either under Article 270 or 272, and unconditional grants under Article 275 or under an Alternative Devolution Scheme recommended by the Tenth Finance Commission and accepted by the Government of India under which 29 per cent of the gross yield from all Central taxes will be shared with the states in addition to providing unconditional grants under Article 275, if necessary.

Federal Transfers to Minimise Vertical Fiscal Imbalance

All the past ten Finance Commissions have no doubt recommended gradually increasing amounts of federal financial transfers from the Centre to the states mainly to reduce the vertical federal fiscal imbalance. But they have not given adequate attention to the task of minimising horizontal federal fiscal imbalance. It is not sufficient if the imbalance between the revenues and expenditures of all the states is reduced at the aggregate level by transferring some revenues from the Centre to the states. For such transfers will not enable every state to provide the benefits of essential public services to its people comparable to those of other states owing to the existence of inequalities of revenue raising capacity. It has been accepted in all civilised societies that certain essential government services of the nature of ‘pure public goods’-such as general administration, police and justice-should be provided equally to every citizen whether he demands them voluntarily or not, and whether he is prepared and able to pay for them or not. Besides, a minimum level of certain social services of the nature of ‘merit goods’-such as primary education, primary health facilities and road communications-have to be provided to every citizen whether he asks for them voluntarily or not, and weather he is prepared and able to pay for them or not. Since some of these essential public and social services involve wide-spread externalities, they have come to be accepted as the responsibility of the government. ‘Merit goods’ can be allowed to be provided by the market mechanism. But in that case, not all people, particularly in a poor country like India, can afford them in socially desirable quantities. So they have to be provided, at least partially, by the governments of the democratic countries. Provision for such public and social services has been one of the objectives of federal financial transfers in Australia, Canada and, in recent years, in the USA.

In India, this social responsibility has been accepted by the public authorities. However, the responsibility has been mostly assigned to the states which lack sufficient funds to ensure a uniform level of essential public and social services to their people. Although the Finance Commissions have been recommending increasing amounts of federal financial transfers from the Centre to the states, yet no serious attempt has been made by them to promote equalisation of these services across the states through their scheme of federal financial transfers.

Equalising Standard of Essential Public and Social Services

In India, the number of states has been increasing and these states vary very widely in their area as well as population. Further, they differ in their levels of economic development (as indicated by their per capita incomes), levels of revenue raising capacity, and even in the standards of administration. Consequently, the extent of horizontal federal financial imbalance is wide in India. Under these circumstances, there exists a wide disparity between the levels of public and social services provided by the richest and the poorest states. So it is necessary to reduce such disparity by lifting the level of the poorest states. This policy has been recognised by the previous Finance Commissions.

But they have failed to recommend federal financial transfers with a view to reducing such disparity. No doubt, the First Finance Commission tried to achieve it partially. But the Second Finance Commission disapproved of such an approach on the ground that “since the total resources are limited, this can be achieved only by stages. We have taken the view that it is the function of the Planning Commission and the National Development Council to ensure the equalisation of the standard of essential social services in the various states of Union.

To the extent the plan expenditure incurred on raising the level of social services has become committed expenditure, we have taken it into account. For our scheme of devolution, we have accepted the plan as ensuring an equitable development in the field of social services". This escapist view has been endorsed by the successive Finance Commissions and as a result the Finance Commissions have failed to make a dent in the field of equalising certain essential public and social services in the Indian federation.

It is true that the Planning Commission has been formulating national plans with a view to developing certain social services in every state. But there has never been an attempt to equalise them. Further, the Planning Commission has never been concerned with the development of essential government services as many of them fall under non-plan programmes. So the justification of the Second Finance Commission, which was accepted by the Central government until recently, has not been borne out by past experience. But what is relevant now is that even if the Planning Commission tries to develop these social services, in actual practice they may develop disproportionately in different states. Hence, the Finance Commission should be allowed to examine such inevitable disparities once in five years and equalise the levels of certain essential public and social services among the states. This will also coincide with the completion of a Five Year Plan and hence the Finance Commission’s evaluative role will logically fit into the scheme of ‘development with social justice’. This function of the Finance Commission becomes complementary to that of the Planning Commission and not overlapping as the Fifth Finance Commission observed.

Method of Achieving Such Equalisation

There is another issue relating to the equalisation of essential public and social services by the Finance Commission. The Finance Commission can achieve it only through financial inducements. Besides, the Commission is supposed to recommend only unconditional grants under Article 275. But it is argued that equalisation of essential public and social services could be achieved only through conditional grants for specific purposes, and there must be an evaluation body to ensure the use of such grants for the intended purposes. The Second Finance Commission felt that in the absence of such a body, they could not recommend special grants. The Third Finance Commission, however, felt that it was enough to attach the condition to use the special grants for achieving equalisation and leave the states free for reallocation if necessary. But the later Commission did not agree with this view and instead followed the reasoning advanced by the Second Finance Commission.

However, all the past Finance Commissions have failed to realise that they were recommending only grants for some specific purposes and the Planning Commission would act as an assessing agency while determining the outlay on social services. Further, as the Finance Commissions never recommended unconditional grants on the basis of net fiscal needs of the states, their apprehension of the purposes not being achieved was not quite warranted. And in the context of the suggested alternative approach, which treats the net fiscal needs of the states as an essential basis of unconditional grants, any apprehension of the future Finance Commission is unwarranted. For, under the suggested alternative approach, no special unconditional grant is required to be made for equalising certain essential public and social services. Instead, the difference between the level of expenditure on such services in the richest states and the level of expenditure in other states will be adjusted while working out net fiscal needs. Further, the Planning Commission should realise that the Finance Commission will be doing a job which has long been neglected by it, perhaps rightly. The Central government should also realise that the Planning Commission should give more emphasis to growth while making plan grants though regional development has become an integral part of the plans. And the Finance Commission should attempt to reduce wide disparities in certain public and social services over and above reducing vertical federal fiscal imbalance. This can be done by estimating gross and net fiscal needs of the states and recommending the transfer of revenue from the Central government in the form of tax shares and grants-in-aid under Article 275. Such a method will also encourage prudent financial management by the states and ensure a certain level of public and social services to the citizens of all the states.

Estimating Fiscal Needs of the States

The Finance Commission may adopt the following method of estimating the fiscal needs of the states for recommending financial transfers.

Asking for Central Government Memo on Revenue Surplus

First, it should review the past financial position of the Central government on the current account and examine the future position for about five years-the period covered by its recommendations. Instead of accepting whatever is reported by the Union Ministry of Finance, the Finance Commission should ask the Central government to submit formally its own memorandum outlining the revenue surplus it might spare for the non-plan current expenditures of the states over the period of the next five years. In fact, one of the terms of reference of the recent Finance Commissions suggests that they should take into account the expenditure obligations of the Central government while recommending financial transfers. But there has never been any mention of taking into account its revenue surpluses. The Finance Commission is not debarred from asking for a memorandum from the Central government by the provisions of Article 280, or by the provisions of the Finance Commission (Miscellaneous Provisions), Act 1951, as amended in 1955. The Central government may use such a memorandum to comment on the demands of the states, the principles adopted by the past Finance Commissions and suggest justifiable modifications in them. However, the Finance Commissions are not bound by such suggestions whether they come from the Centre or states. Such a memorandum and its examination by the Finance Commission need not weaken the position of the Central government. For, the Central government need not accept all the recommendations of the Finance Commission if they are not sound, compelling, or practicable enough. Further, the memorandum gives the Central government an opportunity to make its points of view known to the Finance Commission publicly. In fact, this has been done by the Australian Commonwealth Government through a memorandum to the Commonwealth Grants Commission. Furthermore, in the past, there were many confusions about the scope of recommendations of the Finance Commission and whenever the Central government did not agree with the Finance Commission, it used to make its views known to the Commission through the Member-Secretary. Such confusions and irregular methods may be avoided by asking the Central government to submit a formal memorandum.

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