Whats so special about the weaker states

Written by Raj Kumar Ray | Updated: Mar 20 2013, 08:29am hrs
When individual efforts and even central assistance fail to yield desired results, states start demanding for special category status. However, this status cannot be arbitrarily granted

What are special category states

The government classifies states under the special category if they are located in hills, share international borders, have low per capita income and a low industrial base that restricts them from scaling up revenues and meeting their expenditures. Accordingly, central funds are allocated to accelerate economic development in these states.

According to a formula framed by former Planning Commission deputy chairman DR Gadgil in 1969, only three statesJammu & Kashmir, Assam and Nagalandqualified as special category states. The formula was modified in 1991 when Pranab Mukherjee was deputy chairman of the Planning Commission and reclassified as the Gadgil-Mukherjee formula. The formula was again revised in 2000. As a result of periodic reviews, the list of special category states now includes 11 statesall the seven north-eastern states, Sikkim, Himachal Pradesh, Uttarakhand and Jammu & Kashmir.

Which other states are demanding special status

Bihar has been the most vocal in demanding special treatment. Chief minister Nitish Kumar has raised this issue at the National Development Council meeting last year and is actively parleying for it with the central government. Other states such as Chhattisgarh, Jharkhand, Odisha and Rajasthan have also been demanding special category status for a decade, citing economic backwardness, difficult terrain and international borders.

What extra benefits are enjoyed by special category states

Apart from the share of central taxes as determined by finance commissions under the devolution formula (it was raised to 32% for all states by the 13th Finance Commission for 2010-15 from 30.5% in the previous five years), the special category states are entitled to get 30% of the Centres total Plan assistance. Of this share of central assistance, 90% is given as grants and 10% in loans to the special category states.

On top of these, the Centre offers full exemption from excise duties to companies setting up industrial units in these states for the first 10 years of production. Income tax exemption is also provided100% exemption for first five years and 30% for next five years. Companies also get capital investment subsidy at the rate of 15% of their investment in plant and machinery. There are also other benefits under various schemes.

How did some of the mineral-rich states like Bihar became economically weak

Despite their mineral reserves, eastern statesBihar, West Bengal, Orissahave gradually became economically weak after the 1960s due a policy change initiated by TT Krishnamachari, who was finance minister during 1964-66. The industrialist-turned-politician from Tamil Nadu introduced a scheme of freight-equalisation in the mid-1960s to ensure availability of coal, iron and cement at the same price throughout the country, neutralising the natural advantage of mineral-rich states. This led to the deprivation of eastern states like Bihar, West Bengal and Orissa. This not only retarded industrialisation in the eastern states but also subsidised the transportation of minerals to other states. According to one estimate, Bihar lost R1,12,812 crore just through the freight-equalisation of steel.

Do states like Bihar qualify for special category status

Bihar may match some of the special category states in terms of economic and infrastructural backwardness, and non-viable nature of state finance. Though much of its land is affected by floods every year, the state does not have difficult terrains. The state has an international border, but that is with friendly neighbour Nepal, unlike J&K or Arunachal Pradesh, which share their borders with Pakistan and China. Bihar also does not qualify on the population density criteria.

How do states get compensated for their economic weakness

The Finance Commissions revenue-sharing formula is broadly based on four parameterspopulation, area, fiscal capacity distance (potential per capita revenue) and fiscal discipline. While weight for population (25%) and area (10%) was same for both 12th and 13th finance panels, the weight for the other two differed. While the 12th Finance Commission had attached 50% weight to fiscal or income distance, 7.5% to fiscal discipline and 7.5% to tax effort, the 13th Finance Commission attached 47.5% to fiscal capacity distance and 17.5% to fiscal discipline to arrive at the devolution formula.

Do the fates of some states change with the tweaking of the devolution formula

The change in devolution formula changes the allocation of central funds to states. An analysis by ICRA shows the share of central funds decreased for 10 states including economically weaker Bihar, Orissa, Chhattisgarh, Jharkhand and Kerala. The share of central funds increased for 18 states including all the 11 special category states.

Going by the Finance Commissions devolution formula, the share of revenue was 53% of the total transfers during 2012-13 as the Centre also assists states through grants and loans. While transfer of tax revenue totalled R3.02 lakh crore, total transfers (taxes, grants and loans taken together) from the Centre to states was estimated at R5.68 lakh crore.

Considering the overall transfers, most of the weaker states have got a fair share of the central resources going by their population and contribution to GDP. For instance, Bihar, with a population share of 8.6% and contributing just 2.8% to the national GDP obtained 11% of the Centres revenue transfers to states and 8.8% of the total central transfers to states in the form of taxes, grants and loans. In contrast, an economically strong state like Gujarat got 3% of all of central revenues and transfers despite contributing 7.5% to the national GDP.

What are the ways that Centre can explore to help weaker states without granting special category status

While the Centre cannot arbitrarily grant special status to any particular state based on the existing parameters, it can infuse more funds to some non-special category states from its Backward Region Grants Funds as it was announced in the Budget for 2013-14 for Bihar. The Centre can also request the 14th Finance Commission to tweak the formula for determining the transfer of central resources to states. For instance, increasing the weight for fiscal capacity distance and reducing the weight for fiscal discipline can ensure greater fund flows to some of the weaker states.

However, economists flay any change in the devolution formula that incentivises non-performers and punishes performers. Which is why the 14th Finance Commission headed by YV Reddy has to strike a balance so that the devolution formula does not distort fund transfers and leads to sub-optimal allocation of the centre's resources especially when the government is striving to curb its fiscal deficit to 3% by the end of 12th Plan period ending 2016-17.