The Finance Commission Doesn’t Rock the Federal Boat

Context: An analysis of the recommendations (and their approvals) of the Fifteenth Finance Commission (FFC).

Significance of the report:

• The report seeks to achieve responsible, efficient, equitable, and inclusive growth for India amid an unparalleled global and domestic macro-economic backdrop.

Features of continuity in the report:

• Share of the divisible pool: has been continued with 41% (1% lower after adjustment for the share of Jammu and Kashmir).
• Performance-based grants: Horizontal share of grants are same as before.
• Recommendation of revenue deficit grants: 4 trillion rupees for five years.

Changes recommended in the report:

• Phased reduction of the revenue deficit grants: The number of states eligible for these grants is reduced from 17 to 6.
• Disaster management: Set up disaster mitigation funds at both Union and state levels, in addition to already existing disaster relief funds.
• Grants to the local bodies: Recommended a grant of Rs4.36 trillion for 2021-26 to be distributed among the states based on population and area in the ratio 90:10.
  • Provision of entry-level conditions: for the states to qualify for such grants, These include
    • Setting up of State Finance Commissions;
    • Acting upon their recommendations;
    • Laying the explanatory memorandum as to the action taken report before the state legislature on or before March 2024;
    • Both provisional and audited accounts should be placed in the public domain and there should be a minimum floor for property tax rates in tandem with the GSDP.
    • For non-million-plus cities, grants tied to (60%) 2 basic services (sanitation and drinking water)
    • For million-plus cities, the entire grant is performance-linked through the million-plus Cities Challenge Fund.
• Sector-based grants: to health, school education, higher education, agriculture, maintenance of PMGSY roads, aspirational districts and blocks, judiciary and statistics.
• A dedicated non-lapsable, modernisation fund for defence and internal security (to be audited by the Comptroller and Auditor General (CAG)) to be utilised for:
  • Capital investment for modernisation of defence services,
  • Capital investment for central police forces & modernisation of state police forces as projected by Ministry of Home Affairs.
  • A small component as a welfare fund for soldiers and paramilitary personnel.
• Fiscal consolidation: assumed the growth at 7.4% of the GDP and a path to contain the fiscal deficit at 4% in 2025-26 (containing the debt-GDP from 62.9% in 2021-22 to 56.6% in the terminal year.)
  • For states, the fiscal deficit is supposed to be reduced from 3.3% in 2021-22 to 2.8% in 2025-26 and marginally reduce the debt-GDP ratio from 31% in 2021-22 to 30.5% in 2025-16.
  • The states have also been allowed to borrow 4% of their GSDP in 2021-22 to overcome fiscal constraints and an additional 5% conditional on the reforms in the power sector.
• Independent Fiscal Council: An advisory body with powers to access records required from the Union as well as the states - to ensure better compliance and to act as a repository of fiscal data.

Reservations with the Fifteenth Finance Commission (FFC) report:

• Breach of Federal Mandate: The Term Of Reference (TOR) of the Commission is only to recommend “measures to augment consolidated funds of the states to supplement the resources of local bodies based on the recommendations of the State Finance Commission”.
  • The responsibility for the local bodies is assigned to the states entirely under Entry 5 of the state list in the seventh schedule of the Constitution.
  • It is the responsibility of the governor to appoint the State Finance Commission and cause the report to be placed in the State legislature.
• Incoherence with Budget estimates: As against the estimate of 7.4% of GDP taken by the Commission, the revised estimate shown in the budget is 9.5%.