15th Finance Commission: Getting ready for the new normal

The Fifteenth Finance Commission’s recommendations will go a long way in strengthening the pillars of fiscal federalism

The Commission felt that this level of vertical transfers will allow appropriate fiscal space for the Union as well as help states to meet their demands of unconditional resource transfers from the Union.

By Aditi Pathak & Shikha Dahiya

Since its constitution on November 27, 2017, the Fifteenth Finance Commission’s Terms of Reference evoked concerns from some states owing to its mandate for the use of population data from census 2011 instead of 1971. There were also issues like creation of non-lapsable defence fund and use of certain parameters for performance incentives that induced debates in the span of its operation. Besides, it was the first Commission to submit its report in times of a global pandemic that had slowed down economic growth and made the assessment of revenues difficult.

The Action Taken report on the Commission’s recommendations was laid in Parliament on February 1, 2021, with of most of the recommendations being accepted by the government of India. The Commission, in its final report, recommended vertical devolution of 41%, making only the required adjustment of around 1% due to the changed status of the erstwhile state of Jammu and Kashmir into the new Union Territories of Ladakh and Jammu and Kashmir, the logic being that the resources for these UTs will now be provided by the Union government. The Commission felt that this level of vertical transfers will allow appropriate fiscal space for the Union as well as help states to meet their demands of unconditional resource transfers from the Union.

For horizontal distribution of revenues, it carefully tried to balance the principles of expenditure needs, equity and efficiency with appropriate weights while deriving the devolution formula. The weightages assigned to population (15%), area (15%) and forest and ecology (10%) represented the ‘need’ criterion, while ‘income distance’ (45%) represented the ‘equity’ criterion. In addition, it gave appropriate weightage to tax and fiscal efforts (2.5%) and demographic performance (12.5%) as ‘efficiency’ criterion to allay the fears of the more efficient states in the country. The use of the demographic performance criterion ensured that states which have done well in terms of demographic management and other human development areas are not penalised. Overall, the Commission managed to maintain the stability and predictability of resources to states with its scheme of devolution. At the same time, the formula also remained fairly progressive to achieve the equity objective.

Like all other Commissions in the past, this Commission also recommended grants-in-aid which fell into five broad categories: (1) revenue deficit grants, (2) grants for local governments, (3) grants for disaster management, (4) sector-specific grants and (5) state-specific grants. Similar grants have been recommended by Commissions in the past. Grants in their very nature tend to be targeted, focusing on the specific sectors they are designed for. Some of these grants have been linked with performance-based criteria to promote these sectors in furtherance of national goals.

Also, attaching performance criteria to grants may enhance transparency along with accountability, providing necessary feedbacks on improving formulation and implementation of policies, thereby leading to better monitoring of expenditures. The Commission recommended grants aggregating to Rs 10,33,062 crore, which is 6.74% of gross revenue receipts to states.

It also recommended a revenue deficit grant of Rs 2,94,514 crore to 17 states, over a period of five years (2021-26). This saw an increase of over 50% from the Fourteenth Finance Commission, wherein these grants were provided to only 11 states. The revenue deficit grants try to account for cost disabilities and fiscal capabilities of states, which may not have been fully addressed by the horizontal devolution formula.

The Fifteenth Finance Commission has recommended grants of Rs 4,36,361 crore from the Union government to local bodies for 2021-26. This is an increase of 52% over the corresponding grant of Rs 2,87,436 crore by its predecessor for the period 2015-20. These grants derive their basis from the 73rd and 74th constitutional amendment Acts, and empower the local governments that are closest to the people at the grassroots level. The sets of efficiency requirements recommended by the Commission for availing local bodies’ grants are quite different.

It may be noted that efficient and smooth functioning and accountability of local bodies has been plagued by (a) absence of timely recommendations of State Finance Commissions, (b) lack of readily accessible accounts and its auditing and (c) inadequate revenue mobilisation especially for municipalities. Finance Commissions in the past have also drawn attention to these issues; however, the success has been limited. The Fifteenth Finance Commission has imposed these as entry-level conditions for availing local bodies’ grants. Another distinguishing feature of these grants is their focus on national priorities of sanitation, solid-waste management and improvement of air quality, particularly in the million-plus population cities. In addition, channelising the health grants through local bodies is an important initiative for achievement of the goal of universal healthcare coverage.

The Commission’s recommendation for setting up of ‘mitigation funds’ at both the national and state levels, in line with the provisions of the Disaster Management Act, is both well-timed and necessary. This fund should be used for those local-level and community-based interventions that reduce risk and promote environment-friendly settlements and livelihood practices.

The Commission’s recommendations on defence and internal security, development of incubation centres, new measures for enhancing resource mobilisation during these tough times and its focus on streamlining the extra-budgetary borrowings make it unique and futuristic in its approach.

In this spirit, and in this time, the objective of the Fifteenth Finance Commission was not only to fulfil the traditional mandate of allocating revenues across levels of government, but also to put in place and reinforce the structures, habits and building blocks to increase our adaptability as a nation, a union of states, and a partner in a more sustainable global trajectory for human development. The Commission’s recommendations will go a long way in strengthening the pillars of fiscal federalism in the country.

Authors worked as Joint Directors in the Fifteenth Finance Commission. Views are personal

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