Not many can claim to be experts in the arcane field of fiscal federalism. And there’s none who has seen the subject close at hand from the States’ point of view, the Centre’s and also from the Finance Commission as has Y.V. Reddy, who has the additional distinction of having been the Governor of the Reserve Bank of India. So, who better to write on the subject than him? Dr. Reddy’s book, Indian Fiscal Federalism (OUP), co-authored with G.R. Reddy, Adviser (Finance), Government of Telangana, was launched in Chennai last week. The Hindu caught up with them for an interaction ahead of the launch. Edited excerpts from the conversation:
You have said in your book that there is a feeling in some quarters that cooperative federalism is being replaced with coercive federalism. What is the basis for this comment?
Some developments have taken place after the 14th Finance Commission’s (FC) recommendations. Cesses and surcharge have increased significantly, even after GST. The States felt that they were being short-changed by the way the Centrally Sponsored Schemes (CSS) were restructured, increasing the share that the State government has to put in and then the way the GST is being administered. The general debate earlier was about the Bihar model competing with the Gujarat model and different States’ models of development competing with each other.
Now, suddenly the “one nation, one policy” sentiment is overtaking the other models. And the Planning Commission, which was a forum for States, is also not there now.
Due to this institutional vacuum, Ministries are directly dealing with CSS. So, the spirit of discussion and dialogue is being replaced by diktats by various Ministries. Some say that there is no dialogue, which is untypical of cooperative federalism.
You’ve said that States are now forced to share more from their own resources in CSS. After your own 14th FC recommendations, the impression was that the Centre was devolving more to the States as it went up from 32% to 42%.
As my co-author G.R. Reddy will explain, the comparison is not between 32% and 42%; what was 39% became 42%, because of the way the computations differed. This increase was more than offset by the other actions on cesses and surcharges and CSS. So there has been virtually no advantage for the States
G.R. Reddy: The 14th FC considered the entire revenue account. Unlike the previous FCs, it considered even the Plan revenue account. As a result, some of the Plan transfers were subsumed under tax devolution.
The difference between 14th FC and others is that the former did away with sector specific grants that amount to 4-5% of the total devolution. If you take these two together, the actual devolution would have been 39% earlier and that became 42%. Even this 3% increase is not very visible because it has been more than neutralised by the Centre. The reality is that it has increased the matching contribution of the States in CSS and done away with 6000 model schools started in 2011; half way through, in 2015-16, it took a decision to terminate the entire scheme of model schools.
The entire burden of running schools and meeting expenditure – both capital and operational expenditure, has now fallen on the States.
They then restructured 66 CSS into 22 umbrella schemes. So there is no change in the number of CSS schemes. All components have remained the same.
Why didn’t States raise the issue?
We have done so before the 15Th FC… and communicated to the Centre that what they had done was not correct.
Immediately after the 14th FC recommendations were accepted, the Hon Prime Minister wrote to us saying ‘now that the States are flush with funds…’, We wrote back saying there is absolutely no increase in the flow of funds to the States, but only a change in the composition of transfers in favour of untied transfers. Now what has happened is there has been a qualitative change in the transfers to States – we are getting more money through untied transfers.
The total transfers as a percentage of gross revenues to the States from the Centre has remained at the same level – 49%.
Aren’t untied transfers desirable? It frees States to use funds for whatever purpose they deem fit…
Whatever additional money to have come through untied transfers is now tied up towards meeting the additional commitment.
In the revised pattern of CSS, you have to put in more money.
You have made a commitment, you can’t ‘uncommit’. But they have changed the pattern. Whatever untied funds you have got, you put in those schemes.
For example, in 2014, Telangana’s contribution to the CSS was around ₹2,000 crore. In 2015-16, because of the change in funding patterns, it has gone up to ₹3,500 crore. So there is additional commitment on the part of the States.
There is further commitment for States, because of termination of some CSS – the model schools scheme is an example. Another is BRGF – backward regions grant fund – for Telangana State, 9 of the then 10 districts were under the BRGF. They substantially reduced allocations under women and child welfare also.
There is a view that there are just too many CSS – money is not efficiently used
The other concern with CSS is that the money is too thinly spread across schemes. For example, if you take education or health, States are spending close to 80%. The Centre is supplementing the States up to only 20%, which does not make much difference. That too comes with conditionalities, submission of uses, visits of Central teams, delays in release of funds. As a result of these procedures, we are unable to fully utilise the Centre’s allocations. I don’t think any State has used the funds from Centre entirely.
So the solution is to offer funds and allow States a free hand?
The Commission under Dr. Reddy recommended the same – that the number of CSS should be restricted to some nationally identified priorities.
Dr. Y.V. Reddy: Basic issue is that Finance Commission is one mechanism which essentially is meant for sharing of taxes and that is based on a formula. 80-90% of transfers to States has always been on tax devolution. In tax devolution, there are no conditions, how much weight you give for population, which census’ population and other consideration namely as fiscal capacity. The only question there is what weight you give. If you give weight equally for efficiency and equity, they cancel out, in some sense.
You mentioned institutional vacuum. Do you think NITI Aayog has not been able to step up to the plate?
There were some deficiencies in the way the Planning Commission functioned. There was an impression given to the States that they had to go to the Commission as a supplicant but not for discussion. That was its weakness which had to be corrected. In the correction process, that bad habit was got rid of but there was no new system. There is no forum now. Each Ministry has become an authority unto itself and is able to dictate terms to the States.
Is it deliberate that the Aayog does not have power or did it evolve thus?
That is a question mark. Whether it was by design or by default, the result is that the individual Ministries are indicating to the States, which means there is no coherent and comprehensive view of the States in the process.
There is a view that some of the terms of reference of the 15th FC may not stand the test of constitutional validity. What’s your view?
There are 3-4 issues. It is true that it generated unprecedented reaction. Never before for an FC have a number of CMs got together and protested. Also, some scholars questioned the constitutional validity of some Terms of Reference – for example, whether there is need for revenue deficit.
The constitution provides for it and each FC needs to decide on this. Third, the 15th FC has been asked to review the 14th FC. It is a continuing process. Above all, the Commission has been asked to make recommendations keeping in view some performance indicators and that States should conform to certain policy parameters, which reflected the existing policy of the Centre.
The way the FC is structured, it is not supposed to be an instrument of the central government’s priorities of the day. So it has been questioned on several grounds.
Most of the considerations mentioned in the ToR are not necessarily binding on the FC. The Commission can choose to or choose not to take these into account. But it needs courage and vision for the Commission to do so – we are hoping that will be there.
What’s your view on the controversy over the base date of population census in the 15th FC?
The whole question is whether it is a correct thing or not. It is difficult to defend outdated population as the basis. Because the FC is supposed to take into account the needs of the State for the period. How can 1971 population determine the needs of the State in 2021? It was undertaken on the grounds that States should not be penalised. But what about States that have taken action on family planning after 1971? They don’t get anything. It should be a continuing incentive, right?
This time, they prescribed 2011 population. That is also not valid. The FC recommendations are from 2020. So you should have estimated population of the States for the period 2020-2025. Ideally, there should be no stipulation of a date for population and should be left to the FC but if at all, one should have the population relevant for the period.
Isn’t GST a good example of cooperative fiscal federalism?
It is an extraordinary institution and is commendable. It did not come into existence overnight. It started as an informal committee in the Finance Ministry and has evolved. In the implementation, there has been dissatisfaction expressed. The fact that the Centre has a veto increases its influence. But that is part of the game. Concerns may be there in the way it is working. But as an institutional set up, it is extraordinarily good. It is a good example of collaboration and cooperation in an institution between the Union and the States.
Can this be replicated in other areas?
Exactly. This is on the revenue side. On the expenditure side, fiscal transfers outside the FC, it can be brought under some inter-State council. That was the recommendation of the 14th FC.
The GST Council may not be replicated but is a good approach to build on. On the expenditure side, it is a different type of collaboration, compared to the revenue side.
Is that a recommendation that the 15th FC can give?
Yes. The transfers to the States from the Centre can take FC and non-FC routes. The 14th FC gave recommendations on how to structure the non-FC transfers. It’s only in the ambit of advice.
There are three approaches: virtually abolish the Commission by making a constitutional amendment and say this will be the percentage; the second is to have a continuous FC, a GST Council type of mechanism but the FC gets subsumed in this; the third is to have the FC and a design of new institutional arrangements which will be more technical, more political and more consensus-based, as recommended by the 14th FC.
All this is provoked partly because of the GST Council which has been positive and partly because of the institutional vacuum — both these are pushing us to find new institutional mechanisms.
Pleasantly surprised at the functioning of the GST Council. It comprises people with varying vote bank compulsions.
The consensus has been the result of number of years of effort. Consultative process has been going on for the last 10-15 years. States also are convinced that it is a win-win situation, for the sake of tax harmonisation across the country, they felt it was better. And there was also the feeling that GST is a better form of tax, leading to better compliance. It builds up a value chain. Initially, there was some apprehension on part of manufacturing States that they may lose out this being a destination tax. So we have put in place a 2 year statutory mechanism that they will be compensated for a period of 5 years. The states have yielded lot more space than the Centre. For States, VAT constituted about 60% of their old tax revenue. They have conceded 50% of their fiscal space to the Centre, whereas the space conceded by the Centre is only 30%. They still get customs duty, income tax etc. In the working, there is still a trust deficit because the voting pattern is fully loaded in favour of the Centre, which has almost a veto power.
Then, the way the GST is administered is also raising apprehensions in the minds of the people that they are not being treated fairly by the Centre. Like delays in apportionment of IGST, delays in payment of compensation cess, collecting more compensation cess than required. Best thing to do is to reduce compensation cess correspondingly that they are not doing. So there is surplus compensation cess lying with the Centre to be distributed after 5 years. It is for the Centre to set the record straight and remove this trust deficit.
On the special category status for Andhra Pradesh, what was the stand that you took in the 14th FC?
Special category status is not under the jurisdiction of any FC. In my book, I have explained the Centre’s version of the relationship between 14th FC recommendation and the special category.
If you want the simple truth, 14th FC did not make any recommendation on inclusion or exclusion of special category. The issue of according special category status and assurance by the PM was given months before the 14th FC could give recommendations.
But the government has its own explanation as to why it interprets the recommendations of 14th FC with regard to special category status. I have given that in the book. It is for the reader to decide why and how these are related.
Cess is becoming a monster in the administrative system. With GST we assumed that cess won’t any longer be a part of the system. But with Kerala, we have a disaster cess. Isn’t the purpose of a reform lost with such acts?
There is a calamity fund and the Centre is expected to come to the assistance of states when such things happen and there is always a burden sharing, you can’t anticipate this. Now the recourse to cess for such things is unusual.
Isnt this a step away from cooperative fiscal federalism? The Council is telling one state that funds needed for rebuilding after a disaster are to be generated from within that State…
That is why some of them are dissenting calling it coercive federalism. These are ‘innovations’ that some States are uncomfortable with.
You have Kerala at the upper end of the social development scale and Uttarakhand at the lower end; T.N., Gujarat and Maharashtra at the higher end of the economic development index with Odisha and Bihar at the other. How is it possible for any central body, including the FC to reconcile these differences?
That is exactly the issue with regard to any federation. In any federation there are competing considerations. You have to build trust amongst yourselves so therefore there is no fixed formula. That’s how you operate the system.
What is needed is for the Centre to be able to bring together the States and treat these inequalities or calamities as a national problem in which both Union and States participate. Problem now is that whenever a State opposes the Centre it is accused of being anti-national. Being anti-union is not anti-national.
There are 3 levels of debate – State interest, Union interest, national interest. To build a national consensus, the Union and States must be together. If the States get the feeling that the Union has abrogated to itself the sole authority of national interest, the States resent it. That is the essence of the matter.
How much is this because of a strong leader at the top?
You should go back to Constituent Assembly debates. Dr Ambedkar when introducing the draft constitution, discusses the merits and demerits of parliamentary and presidential form of government and says why parliamentary system is important for India. He says that India is essentially undemocratic and therefore emphasises on continuous accountability. He says continuous accountability is more important than stability. That was the deliberate choice on this type of issue.
In 14th FC, you recommended forest cover as a determinant. In the five years that have lapsed, have you studied how that recommendation has helped India’s environment cause?
No. But it’s an interesting area where we have to see the impact of the recommendation. But the logic is simple – forest cover. The state govt is contributing to environment at a cost to itself. It cannot use the resource but has to maintain it. So you have to provide for it. The basic principle is externalities. The state is contributing at its own cost – it does not gain anything. It incurs cost to maintain the forest.