A government is ideally supposed to use tax revenue to provide public goods and services to its citizens, goods that the market cannot do a good job of providing. Tax revenue can also be redistributed to make poorer citizens relatively better off than before government intervention. In a federal country like India, there is the complication of different levels of government, each with its own responsibilities and loci of authority. Because the Centre is more efficient at raising tax revenue, there are provisions for sharing central tax revenue with the states. The 14th Finance Commission is now hard at work on making those sharing decisions. Like its predecessors, it will use a formula justified according to a mix of economic and political logic and of precedent. The Finance Commission is an explicit creature of India’s Constitution.
Less firmly founded in constitutional directives, but more in the middle of political bargaining, the Planning Commission (along with various central ministries) also makes transfers to the states. These are based on more varied and discretionary criteria, with its own modified Gadgil formula playing a relatively small role. The Planning Commission introduced the concept of Special Category states, and has given them a healthy share of the pie that it disburses. These states have been, as a natural consequence of the criteria used, mountainous border states with populations whose ethnicity or religion are not part of the “mainstream” Indian identity. They were ostensibly compensated for having high cost structures for public good provision, but I have always thought of their shares of the pie partly as payments for sticking with the rest of the nation.
The Special Category designation has bothered the leaders of some bigger, poorer states, which have been demanding to be included in that classification, therefore getting more central money. Many committees have looked into the criteria to be used for such transfers (which are broadly thought of as promoting “development”) but not made much headway. Hence, a new committee, headed by the ubiquitous Raghuram Rajan, was formed, and has just given its report to the Finance Minister. This committee has created a