A Partition Federalism

Context: Fifteenth Finance Commission (XVFC) dips into states’ share for Centre’s expenditure, makes the system more discretionary.

FFC recommendations: with regards to devolution to the states

• Principled and pragmatic: by retaining the share of states in central taxes at 42% (accepted by government).
• Revenue deficit grants: of Rs 1.18 lakh crore to the states have been provided in the budget as per the recommendation of the FFC.

Federal concerns with FFC recommendations:

• Reduced grants to states because of Exclusive Expenditure on defence: 1% of the grants to states and about 0.5% of the total transfers to finance the Centre’s exclusive defence expenditure.
  • Against constitutional mandate: The first charge on taxes collected is devolution and statutory commitments, not the Centre’s expenditure.
• Issue of horizontal distribution: moving towards partisan federalism.
  • Moving away from need and equity-based devolution towards performance and efficiency-based devolution: From 92.5% of funds to a state being devolved based on need and equity, the XVFC has reduced these two components to 75% (remaining 25% based on efficiency and performance).
  • Lowest weightage for equity makes the XVFC transfers potentially the least progressive ever.
• Flawed distributional criteria: based on production-based tax system instead of a consumption-based tax system.
• Makes the system more discretionary: by increasing the share of total grants (statutory and non-statutory) - 55% of total transfers, and reducing tax devolution in aggregate transfers - 45%.

Suggestions:

• Move towards consumption-based tax system: which will make a significant difference to distribution and the need, nature and distribution of equalizing grants.
• The “gap-filling” approach should be redesigned in light of the compensation law providing a minimum-guaranteed revenue if 14% to every state.