The appointment of the Fifteenth Finance Commission by the President of India under Article 280 of the Constitution was notified on November 27, 2017. It was required to submit the report by October 30, 2019 for five years for the period 2020-21 to 2024-25. However, due to various political and fiscal developments, notifications were issued first, on July 27 extending the tenure of the Commission up to November 30, 2019, and again on November 29 requiring it to submit two reports, one for 2020-21 and the second covering the period of five years beginning April 1, 2021 and further extending the tenure up to October 30, 2021. The first report submitted by the Commission was placed in Parliament by the Union Finance Minister before presenting the Union Budget on February 1, 2019.
Basis for extension
There were good reasons for extending the tenure of the Finance Commission as making medium-term projections in the current scenario would have entailed serious risks. First, the abolition of Statehood to Jammu and Kashmir required the Commission to make an estimation excluding the Union Territory. Second, the deceleration in growth and low inflation has substantially slowed down the nominal GDP growth which is the main tax base proxy; making projections of tax revenues and expenditures based on this for the medium term could have posed serious risks. Finally, poor revenue performance of tax collection and more particularly Goods and Services Tax combined with the fact that the compensation agreement to the loss of revenue to the States was effective only two years of the period covered by the Commission’s recommendations posed uncertainties.
On projections
The Commission has continued with the approach and methodology adopted by the previous Commissions for tax devolution and revenue-gap grants. It has made projections of revenues and revenue expenditures of the Union and individual States, applied selective norms to the latter, recommended devolution of taxes to the States from the divisible pool, and recommended revenue deficit grants for the States which had post-devolution gaps. Although there were apprehensions that it may deviate from past practice as the terms of reference of the Commission had indicated, “The Commission may also examine whether revenue deficit grants be provided at all”, it continued with the past practice.
By stating that, “…stability and predictability of resources is an essential component of good long-term budgeting for both Union and States”, the Fifteenth Finance Commission continued with the recommendation of the previous Commission relating to vertical division of taxes, and adjusted the States’ share to 41% to exclude the share of Jammu and Kashmir. There were media reports that the share would be reduced and by maintaining the share, the Commission has avoided controversy.
However, for the period 2021-25, it has stated: “Our recommendation in the final report would undergo changes and adjustments as appropriate, in the light of subsequent data and analysis”. For the horizontal shares, however, the formula has been changed to consider “fiscal needs, equity and efficiency”.
Addressing States’ concerns
In addition to income distance, population and area and forest cover, it has used two additional factors — demographic performance and tax effort. It has assigned 15% weight to the 2011 population, reduced the weight of income distance to 45%, increased the weight to forest cover and ecology to 10% and 12.5% weight to demographic performance and 2.5% weight to tax effort. There was considerable controversy over the terms of reference of the Commission requiring it to use 2011 population in its formula by the States that had taken initiatives to arrest population growth.
By keeping the weight of 2011 population at 15% and giving an additional 12.5% to demographic performance which is the inverse of fertility rate, the Commission has shown sensitivity to the concerns of these States.
In terms of relative shares in tax devolution, among the major States the biggest loser is Karnataka followed by Uttar Pradesh, Kerala, Telangana and Andhra Pradesh. Kerala and Andhra Pradesh have post-devolution gaps and hence qualify for revenue gap grants. The major reason for Karnataka and Kerala losing on devolution is that their per capita income growth has been faster than most other States. The difference from the highest per capita income in both Karnataka and Kerala is just about 10% now as compared to 34% and 23%, respectively, for the two States when the Fourteenth Finance Commission made the recommendation. In the case of Karnataka and Telangana, as the projected transfer (devolution and revenue-gap grants) in 2020-21 were lower than 2019-20, the Commission recommended a special grant of ₹5,495 crore and ₹723 crore, respectively. However, the government has not accepted the recommendation and has asked the Commission to reconsider it.
Local body grants
The recommended grants for local bodies amount to ₹90,000 crore comprising ₹60,750 crore for panchayats and the remaining ₹29,250 crore for municipal bodies. All the three layers of panchayats will receive the grant and 50% of the grant is tied to improving sanitation and supply of drinking water; the remaining is untied. In the case of municipal bodies, ₹9,229 crore is allocated to cities with a million-plus population and the remaining ₹20,021 is allocated to other towns. In the case of disaster relief, the Commission has recommended the creation of disaster mitigation fund at the Central and State levels. For disaster management, a total of ₹28,183 crore has been determined of which the Central contribution will be ₹22,184 crore. Inter-State allocation is made based on past expenditures, area and population and disaster risk index.
The Commission has worked out a framework for giving some sectoral grants as well. For 2020-21, it has recommended ₹7,735 crore for improving nutrition based on the numbers of children in the 0-6 age group and lactating mothers. In the main report, it has proposed to give grants for police training, modernisation and housing, railway projects in States taken on a cost-sharing basis, maintenance of the Pradhan Mantri Gram Sadak Yojana roads, strengthening the judicial system, and improving the statistical system. The States are required to prepare the necessary grounds. It has also presented a broad framework for recommending monitorable performance grants for agricultural reform, development of aspirational districts and blocks, power sector reform, and incentives to enhance trade including exports and pre-primary education. The challenge, however, will be to design and dovetail sectoral and performance grants with the existing plethora of central sector and centrally sponsored schemes.
M. Govinda Rao is former Director, National Institute of Public Finance and Policy (NIPFP) and Member, Fourteenth Finance Commission
