The 13th Finance Commission (TFC), whose report was tabled in Parliament recently, has broken new ground by building incentives into the transfer mechanism. Most of its key recommendations have been accepted by the government. The States stand to get a larger share of central taxes than before. Apart from increasing their share of the divisible pool of tax revenues from 30.5 per cent to 32 per cent, the Commission has proposed an additional 2-2.5 per cent for local bodies. Grants-in-aid to States are projected at Rs.315,581 crore over the next five years. The shared taxes and central grants together will take the overall devolution to States from 37.6 per cent to 39 per cent of the central divisible tax revenues. The TFC does not want any inconsistency between the amounts released to the States and the percentage share in the net tax revenues recommended by it. The States have been impressed upon to comply with the norms set by the Commission if they are to avail themselves of the full benefit of certain transfers. It has called upon the Centre not to lean heavily on surcharges and cesses since collections under these heads are not shared with the States. The transfer formula, which emphasises fiscal discipline on the part of the States, has been so worked out that non-Plan revenue grants will be made available to fewer States.

The system of incentive-based transfer seeks to reward States that comply with the norms prescribed by the TFC. However, given the political sensitivity of some of these proposals, the accent is on achieving incremental gains for fiscal federalism. The Commission has earmarked Rs.50,000 crore of central grants to compensate States for any revenue shortfall on account of switching to the Goods and Services Tax. The compensation will be available even if there is no shortfall, provided the State concerned adopts the GST model the TFC has prepared. This however is going to prove contentious. The empowered committee of State Finance Ministers has worked out its own model wherein tax rates are higher than in the TFC's version. The States want a much higher share of the divisible tax receipts to be transferred to them. Nor will they be happy that the Commission has remained silent on their long standing demands, namely decision-making powers in respect of centrally-sponsored schemes. The government has accepted its suggestion to put a cap on the combined debt of the Centre and the States at 48 per cent of the GDP that is to be achieved by 2014-15.