The Finance Commission should be allowed to function in the same manner as it is doing currently, according to former Reserve Bank Governor Y.V. Reddy.
“Let [the] Finance Commission do whatever it is supposed to do. There is no need to tamper with the structure,” he said in a speech on ‘New approaches to fiscal federalism in India’ as part of Madras Institute of Development Studies’ Founder’s Day lecture.
Asked about various views on the need for, and against, a permanent structure for the Commission, he said, “Currently, the Finance Commission has a five-year term. The system of appointing a Finance Commission once in five years is fine. Let it continue. The way forward is to stick to the old approach.... New approach is not warranted. What is warranted is to behave more faithfully, with honesty and integrity,” he said.
Pointing out that the proposal for making the Finance Commission a permanent body could evolve in two ways, he said: “First, the government would abdicate its discretion currently available in designing and implementing the specific purpose transfers. Second, it would dilute the neutrality of the Finance Commission between the Union and the States through a process of continuous association with the government.”
Dr. Reddy said that in his view, there was considerable merit in having one apolitical body that provided stability and predictability primarily to share taxes that ensured fiscal balance and another forum of transfers involving continuous political bargaining with a broader mandate.
“The former exists in the body of Finance Commission and the latter does not exist. The problem and the solution therefore are not with the Finance Commission but outside of it in terms of institutional structures,” he said.
The way forward for fiscal federalism in India is to refocus the scope of Finance Commission to maintain the trust of all stakeholders in the institution and reinvent NITI Aayog to fill the vaccuum for other Central transfers to States,” he said.
“Our story of fiscal federalism is a of remarkable success but in the last four years we are at crossroads,” he added.
The Centre and States were in crossroads because the XIV Finance Commission recommended an increase in tax devolution from 32% to 42%, which was perceived to have considerable adverse impact on the fiscal space of Union.
“Perception is that the States have got lot of money but the reality is otherwise,” he said.
On the Goods and Service tax (GST), he said it was an historic step but the States seem to be disadvantaged in terms of design and implementation.
“By giving up independence of tax power, relative loss of fiscal autonomy of States is more than the Union,” Dr. Reddy said.
“For the first time, there is a whole lot of controversy surrounding the terms of reference of the XV Finance Commission.
“Most of the concerns are in the nature of mistrust between Union and States, and to some extent, lack of transparency, if not misunderstanding,” he added.
He also urged reinventing NITI Aayog with appropriate stature with the benefit of Constitutional legitimacy, possibly linking it to the Inter State Council.