Tax devolution to states will rise a huge and unprecedented 10 percentage points to 42% of the divisible pool of the Centre’s tax revenue between FY16 and FY20, compared with the previous five-year period, as the Narendra Modi government, vouching for cooperative federalism, accepted the recommendations of the 14th Finance Commission (FC).
Along with the commission-prescribed statutory grants, the total untied transfers to states in the next five years will be 47.7% of the pool, up from over 39% between FY11 and FY15, giving a tremendous boost to states’ fiscal space and spending flexibility.
Despite the largesse, the Centre’s fiscal capacity won’t be constrained much either, as aggregate transfers to states from its gross revenue receipts will remain at 49.4% in the next five years, almost the same as now. It also has the option of slashing the discretionary (tied) outlays to the states while remaining committed to Union list items and expending judiciously on programmes that complement states’ spending on items in the concurrent list.
The tied transfers to the states include those under centrally sponsored schemes (CSS), which were reduced to 66 including 17 flagship schemes in the FY15 Budget from 126 earlier, besides various additional central aids and special Plan assistance.
Following the acceptance of the FC’s recommendations, the Centre, in an action-taken report on the same in Parliament on Tuesday, announced withdrawal of financial support to eight CSS and this process could gradually be accelerated. Prime Minister Narendra Modi on Tuesday wrote to the state chief ministers, urging to “tailor-make” CSS as per their needs. However, he iterated that the Centre will continue to support national priority projects like poverty elimination, MNREGA, education, health, rural development and agriculture, among others.
Stating that the Centre is only happy to transfer more resources to states that are going to be strong partners in the development paradigm of the Modi government, finance minister Arun Jaitley said the Centre would expect the states to become financially self-sufficient gradually.
With the higher devolution from the Centre, in the case of many states, these transfers will now become on a par with their own revenue resources. While states’ own revenue was estimated at R8.9 lakh crore in FY14, aggregate transfers to the states is seen to be R8.7 lakh crore in FY16 and over R10 lakh crore in the next year.
As per the FC’s award, the tax devolution to states would rise from R3.82 lakh crore budgeted for FY15 to R5.79 lakh crore in FY16, and untied grants from R64,675 crore to R88,865 crore. A press statement issued by the government, however, put the tax devolution to states in FY16 to be R5.2 lakh crore, also revising the FY15 figure downwards to R3.48 lakh crore.
Outlining the principles that govern the grant-in-aid to states’ revenues by the Centre, the commission, headed by former RBI governor YV Reddy, said the distinction between Plan and non-Plan could be done away with and proposed grants amounting to Rs 1.95 lakh crore over the next five years for 11 states that would continue to be revenue-deficit even after the generous devolution. During FY16, these states, which include post-division Andhra Pradesh, West Bengal, J&K, Kerala, Assam and most northeastern states, will get an extra Rs 48,906 crore.
The FC recommended a total grant of Rs 2.87 lakh crore to local bodies (which is part of the untied transfers to states). It changed the criteria for determining the inter-se shares of states in tax distribution by assigning the highest weight of 50% to ‘income distance’, followed by population (17.5%), area (15%) and demographic change (10%). It introduced the new criterion of forest cover (7.5%) while dispensing with fiscal consolidation as a yardstick, in what showed the increase fiscal autonomy envisaged for states.
Sticking to the fiscal consolidation path drawn by the 13th Finance Commission, Reddy’s panel said “the ceiling on the (Centre’s) fiscal deficit will be 3% of the GDP from the year 2016-17 onwards up to the end of the award period”. It said the gross tax revenue of the Centre as a share of GDP will rise only modestly from 10.6% (Budget estimate) in FY15 to 11.4% in the final year of its award period.
“Fiscal deficit of sates will be anchored to an annual limit of 3% of the gross state domestic product. The states will be eligible for flexibility of 0.25% over and above this for any given year for which the borrowing limits are to be fixed if their debt-GSDP ratio is less than or equal to 25% in the preceding year.”
The commission also recommended the creation of an autonomous and time-bound Goods and Services Tax Compensation Fund through legislative action so that states have reasonable comfort on this front.
