Column: The state of central transfers

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Published: April 7, 2015 12:59:31 AM

Under the new tax devolution regime, it is for states to set their priorities in providing public services

The implementation of the 14th Finance Commission recommendations increasing the tax devolution to the states in the divisible pool by 10 percentage points, from 32% to 42% has triggered changes in both the Union’s and states’ budgeting. For the Union government, this has provided an opportunity to rationalise the non-statutory transfers. Given that the Finance Commission has taken into account the states’ total revenue expenditure requirements, including plan revenue expenditures, the block transfers given by the Planning Commission get subsumed. The higher tax devolution also limits the fiscal space for giving specific purpose transfers and this presents an opportunity to consolidate and restrict the central schemes to those involving significant inter-state externalities or redistributive reasons.

On the states’ side, the opportunity presents itself to rationalise the budget exercise and focus on their Constitutional functions. The immediate challenge relates to realignment of their own spending priorities based on the changed composition of transfers. In fact, they now have the opportunity to rationalise their budgeting by allocating resources to meet their Constitutional obligations without making the artificial distinction between plan and non-plan, and to assign as much priority to the maintenance as to the creation of assets. This does not mean that the states should give up the planning process altogether. After meeting the requirements for the existing programmes, they can allocate expenditures to new schemes to forge a better linking of expenditures to outputs and outcomes.


The way in which the Union government has responded to the Finance Commission’s recommendations can be inferred from the changed size and composition of the transfers from various sources (see accompanying table) in Budget FY16. The first question is, has there been a significant increase in the proposed transfers in FY16 as a consequence of the Finance Commission’s recommendations? The proposed transfers relative to GDP in FY16 (5.9%) show only a marginal increase over the actual of FY14 (5.2%) and revised estimate of FY15 (5.5%).  Whether or not it will be higher will depend on the actual collection of Union tax revenue during the course of the year.  The budget assumes increase in the tax revenue in FY16 by 15.8% over the revised estimate of FY15, which may not be too unrealistic considering the possibility of economic revival and the increase in the rate of service tax.

What is more significant is the change in the composition of transfers. The Finance Commission transfers, now constitute over three-fourths of the total transfers and the share of plan grants have been reduced from about 40% of the total in FY15 to just 24% in FY16.  Thus, the states are poised to receive much higher untied transfers mainly due to the increased tax devolution, the share of which in the total transfers has increased from about a half to about two-thirds.  This enables greater stability, certainty and buoyancy in the transfer system and autonomy in the allocation of funds to public services according to their own preferences and priorities.

The Union government has readjusted the transfers in response to the recommendations of the Finance Commission by classifying the plan grants into three categories.  Some of the programmes which were funded entirely by the Union government continue to be funded by it. The grants for this category for FY16 is budgeted  at R1,18,512 crore or 60% of the total plan assistance or 0.84% of the GDP—the same as in FY15 (RE).  Under this category, five large programmes constitute 75% of the grants and these are additional assistance for externally-aided projects, rural employment guarantee programme, rural roads programme, elementary education financed from cesses on Union taxes and National Social Assistance programme. Of the five, rural roads programme received lower than the previous year’s allocation by 15% even in nominal terms while all other received higher allocations by varying percentages.

The second category of plan transfers will have a changed pattern of assistance. This implies that in respect of these, the states’ matching requirement is likely to be increased.  The allocation to these schemes in the Union Budget in FY16, at R78,230 crore, is lower than the revised estimate of FY15 by 20%. Major schemes under this category include National Rural Health Mission, rural housing (Indira Awas Yojana), drinking water programme, Rashtriya Krishi Vikas Yojana, and Sarva Shiksha Abhiyan (including mid-day meals) financed from gross budgetary support. In order to incur FY15 (RE) level of expenditures on these programmes in nominal terms, the states will have to contribute an additional 30% of the funds. The reduction is especially sharp in the case of agriculture and irrigation (over R5,000 crore), drinking water (R5,000 crore), ICDS, (over R8,000 crore) and elementary education (R9,500 crore).

The third category of programmes has been simply delinked from assistance. These include the Gadgil formula grants, Special Central Assistance and Special Plan Assistance which are given in a discretionary manner by the Planning Commission, for backward region grant fund (both state and district components) and additional central assistance given for various purposes.  Indeed, when the Finance Commission has taken the plan revenue expenditure requirements of the states, the plan assistance gets subsumed including the grants such as backward region grant fund as the devolution formula of the Commission takes into account revenue and cost disabilities.

Thus, it is seen that the Union government has tried to respond to the higher tax devolution by the 14th Finance Commission by discontinuing some grants and increasing the matching requirements of the states in respect of others, while continuing with some schemes that are fully funded by it. Surely, the schemes delinked and those which have suffered significant reduction in support will be debated by the affected states and experts.  In fact, the committee of chief ministers set up by the NITI Aayog will deliberate on the consolidation and rationalisation exercise.  It should also take note of the fact that just five of the of the fully-funded schemes account for 75% of the grants and only 9 schemes retained under changed pattern of assistance account for 80% of the grants in their respective categories.

Finally, the states have always complained about the proliferation of central schemes, their “one size fits all” design and distortions caused by the requirement of matching contributions.  Now that they have been substantially liberated from this, it is for them to set their priorities in providing the public services assigned to them in the Constitution as desired by the people rather than proliferating subsidies and transfers.

The author is  Emeritus Professor at NIPFP and is a former member of the 14th Finance Commission.

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