The institution of the Finance Commission (FC) has been an important constitutional instrument in the maintenance of harmony and balance in federal fiscal relations in India. The core functions of FCs are circumscribed by the relevant constitutional provisions and the prescribed terms of reference (TORs), which usually vary from one FC to another. The core functions primarily relate to recommending the distribution of the divisible pool of taxes between the Union and the states and the inter-se allocation of such proceeds among the states. In addition, FCs are also required by the TORs to keep specific policy issues in mind while formulating their recommendations and suggest measures for maintaining ?a stable and sustainable fiscal environment consistent with equitable growth?. Given the highly sensitive nature of federal fiscal relations, this is a demanding task in the best of circumstances. The task of the 13th Finance Commission was made even more challenging in the context of the significant slowdown of the Indian economy and the wide ranging TORs given to it covering diverse policy issues.
One of the contentious issues before the 13th Finance Commission was the determination of the states? share in the divisible pool of central taxes, especially in the context of the collective representation by the states for raising their share to 50% from the level of 30.5% fixed by the 12th Finance Commission. To create the fiscal space for such a major hike would essentially imply a complete reordering of Centre-State fiscal relations, with drastic curtailment of schematic plan transfers to the states. The 13th Finance Commission has rightly opted for the maintenance of continuity and stability and raised the states? share to 32% based on the strong economic logic of higher tax buoyancy at the Centre vis-a-vis the states, unprecedented increase in the share of the non-divisible pool comprising cesses and surcharges, and the differential impact on the states of the 6th Pay Commission recommendations. In the area of horizontal devolution, the differential treatment of the special category states to their advantage, has been a significant innovation.
Since the direct funding of local bodies was not found to be constitutionally feasible, the 13th Finance Commission has adopted a highly innovative approach for the purpose by linking the grant to local bodies to a prescribed share of the divisible pool of taxes for the previous year. This approach allows the local bodies to leverage the buoyancy in central taxes by effectively mimicking devolution. This has implied an unprecedented hike in the grants to local bodies which would better equip them to deal with pressures of rapid urbanisation. Further, in order to promote good governance along with decentralisation, a performance-based incentive grant has also been proposed for those states which put in place better accounting, governance and outcome monitoring mechanisms.
As far as the issue of fiscal consolidation is concerned, the 13th Finance Commission has taken the elimination of the revenue deficit as the long-term ?golden rule? for both the Centre and the states and also fixed a combined debt target of 68% of the GDP for the Centre and states to be achieved by 2014-15. The fiscal deficit reduction trajectory for the Centre is then a derivative of the debt/GDP ratio target and the prescribed revenue balance path. The normative revenue and expenditure projections on which the fiscal consolidation roadmap is based assumes significant reform in the reduction of subsidies based on various expert committee recommendations. The 13th Finance Commission is categorical in its assessment that the current subsidy regime is both regressive and inefficient and that there is a direct link between the capacity of the state to provide of public goods and subsidy reform.
For the states, the 13th Finance Commission has abandoned ?the one size fits all? approach and prescribed individual debt and revenue balance targets for each state. As a consequence, the resultant fiscal deficit reduction path is also not uniform for different states. This approach addresses a standing grievance of the states which are positioned at different stages of development and fiscal consolidation.
The 13th Finance Commission has been deeply conscious about devising forward looking incentives to promote good governance and better outcomes in the design of grants. Thus grants for the protection of forests are based on forest area and quality of cover; grants for renewable energy are based on achievement of targets; grants for water sector are conditional on setting up a water regulatory authority and minimum levels of recovery. Similarly, grants have also been designed for improving outcomes linked to reduction in infant mortality rates and improvement in the supply of justice. There are, in addition, substantial incentive grants to the local bodies based on governance reform. For the introduction of GST, Rs 50,000 crore incentive has been proposed for implementing the model structure, in the absence of which the full benefits of this major tax reform will remain unrealised.
The 13th Finance Commission report provides a major thrust towards institutional deepening which it feels is essential for a stable and healthy federation. Thus, it has proposed the setting up of a Fiscal Council at the Centre to provide an independent review mechanism of its fiscal reform process. A similar mechanism is also envisaged for the states. At the state level, some of the significant recommendations relate to the creation of local body ombudsmen, setting up of property tax boards, and water regulatory authorities.
Standing on the shoulders of its predecessors, the 13th Finance Commission has attempted to significantly upgrade the quality and depth of federal fiscal relations in India.
(The views are personal)