Article 280 of the Constitution mentions Finance Commission (FC). There is a history behind evolution of federal finance. The obvious bit is Section 142 from Government of India Act (1935). “Such sums as may be prescribed by His Majesty in Council shall be charged on the revenues of the Federation in each year as grants in aid of the revenues of such Provinces as His Majesty may determine to be in need of assistance, and different sums may be prescribed for different Provinces.” But there were reports too. To name three—Indian Financial Enquiry Report (Niemeyer Report, 1936), Krishnamachary Enquiry Committee Report (1948) and Committee on Financial Provisions of Union Constitution (Sarkar Committee, 1948). Why should Provinces need assistance? Equity is the idea. There is a basket of goods and services that should be delivered by the State. It is best not to call them public goods, since “public goods” have a specific meaning for economists and this basket has items that are typically collective private goods. Curlew Island is in Andaman and Nicobar Islands. Till 2011 Census, it had a population of two. Pulomilo Island, also in Andaman and Nicobar, had a population of twenty in 2011. At the time of elections, we read of astounding attempts made, so that voters in remote locations can vote. No one should be disenfranchised because of remoteness of location.
By the same token, a resident, regardless of location, must be entitled to that basket. Provinces, now states, can have differential sources of revenue. Alternatively, cost of delivering that basket may vary, across geographical zones. Over time, villages of course get depopulated. They are reclassified, get absorbed into larger agglomerations, or disappear because of migration. For instance, in 2021 Census, Curlew Island no longer has any inhabitants. Until then, the State cannot abdicate its responsibility of providing the basket. “It cannot be provided in such a remote location. Therefore, migrate.” That would be a most perverse argument. Migration is a voluntary decision, often driven by pull (and push) of economic forces. That voluntary decision cannot be replaced by fiat. Indeed, depopulation is not necessarily desirable. Think of remote villages, along the border, in Arunachal Pradesh. With China forcibly populating villages near the border, it is strategically important that our remote villages do not get depopulated. Indeed, in the last few years, physical and social infrastructure in remote and border areas have vastly improved, countering incentive to migrate. This brings us to the question of cost of delivering that physical and social infrastructure, the basket, and per capita, it is not uniform throughout the country. Union-state and intra-state devolution should be a function of that.
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Computing these costs is no easy task. In 1936, Otto Niemeyer faced the same conundrum. He concluded, it would be fair to “fix the scale of distribution partly on residence and partly on population.” At best, these are surrogate indicators. The Union FC has a vertical task, dividing divisible pool between the Union government and states. It also has a horizontal task, dividing state share between different states. Accordingly, from 1st to 15th, FCs have adopted different formulae, with an attempt to also create incentives, by attaching weights to fiscal efficiency and even demographic performance. This leaves variables like population, geographical area, income distance, infrastructure distance and forest cover. To quote from 15th FC, “There are three broad approaches to measuring fiscal capacity for formula-based transfers: (a) expenditure equalisation based on needs/costs of public services; (b) revenue equalisation measured by the ability of the state to raise revenue from one or more sources; and (c) macro-indicators covering broader economic or non-economic indicators that approximate fiscal capacity where data constraints make it difficult to apply the other approaches.” Let’s think about (a), especially the costs part. Forest cover isn’t necessarily that, since there are positive externalities associated with forest cover and it is an end in itself.
Needs/costs are sought to be measured through geographical area and population, surrogate indicators that go back to Niemeyer. To quote from 15th FC, “The population of a State represents the needs of the State to undertake expenditure for providing services to its residents.” “All Finance Commissions since the FC-X have used area as another criterion in the devolution formula on the ground of need—the larger the area, greater is the expenditure requirement for providing comparable services.” But the point is this. The way I understand it, geographical area is the estimated area of a plane. It isn’t topographical area.
Is it more expensive to deliver physical and social infrastructure on a level plain, or in a hilly area? Clearly, the latter. There is a ranking of states by geographical area. I haven’t seen a similar calculation according to topographical area, though it is logically obvious there will be differences between the two. In this day and age, with improvements in information technology, can’t we compute topographical area objectively and use that instead, as a better surrogate indicator? No FC has tried to do that yet, but that doesn’t mean it can’t be done. (Forest cover doesn’t adequately capture topography.) If I have understood it right, Australia’s National Productivity Commission seeks to measure topography. It’s probably not used for fiscal devolution, as opposed to planning. However, this seems to be an idea worth toying with. Think of small villages in Arunachal Pradesh, at altitudes of more than 10,000 feet.
The author is Chairman, EAC-PM