Finance Commissions and Special Category States

* : This does not include the share of the special category States out of Rs. 60,000 crore devolution set aside by the Thirteenth Finance Commission for compensation to the States on account of the Goods and Services Tax (Rs. 50,000 crore), IMR grants (Rs. 5,000 crore) and grants for promoting renewable energy (Rs. 5,000 crore) for which the inter-State dispensation has not been worked out in the report of the Thirteenth Finance Commission. Thus, in the final run, the total devolution to the States will be slightly higher than what is presented here.

5.         The award tenures of the Seventh and Eighth Finance Commissions covered the then existing eight Special Category States. As such, these should not be compared with the dispensation of the successive Finance Commissions. The gross devolution has moved around 15-16 per cent for the award periods of the Ninth and the Tenth Finance Commissions. The share of Special Category States in the gross devolution was, in fact, highest in the single year award of the Ninth Finance Commission, i.e.1989-90. A certain element of progressivity in the context of Special Category States is visible in the dispensation of the Tenth Finance Commission as compared to the Ninth Finance Commission. The reason contributory to this was the restoration of an earmarked 7.5 per cent transfer of the Union Excise Duties in favour of these States. The award of the Eleventh Finance Commission showed a drastic decline in the gross devolution to the Special Category States from 15.13 per cent of the TFC to 13.44 per cent in the Eleventh Finance Commission dispensation. For the award period of the Twelfth Finance Commission, despite the number of Special Category States increasing from 10 to 11 by addition of the State of Uttarakhand, the devolution to these States came to only 14.42 per cent, whereas the population proportion increased by 0.83 per cent and the area proportion increased by 1.63 per cent. The dispensation of the Thirteenth Finance Commission for the special category States shows a huge decline to 12.48 per cent from 14.42 per cent for the previous commission. The comparative data includes the totality of the transfers, inclusive of the tax shares, revenue deficit grants or any other grants the successive Finance Commissions may have dispensed to the States. The longer view from 1989-90 to 2014-15 indicates that the total devolution from Centre to the Special Category States has continued to decline at the overall level. One wonders whether axiom of equity has been given a comparatively low priority in the design of devolution or the internal resources of these States have attained a comparatively higher resilience vis-à-vis the other States leading to a marginally lower per capita transfer. Or alternatively, the expenditure requirements of these States might have shown better containment or low growth as compared to the other States. We shall see this in the following paragraphs.

6.      The above data presents the overall picture of the transfers to the special category States through the successive Finance Commission but the overall figures are not comparable. In that context ; a comparison of the per cent share of population,  per cent share of area, per cent share of devolution for the successive Finance Commission and the level of per capita devolution in these States vis-à-vis all-India average  level of 1 has been presented in the following table:-

7.         Against the all-India average of 1, the per capita devolution for the Special Category States has ranged between 1.968 for the Seventh Finance Commission period to 3.255 for the single year award of the Ninth Finance Commission (1989-90). It is, however, important to view this decline as a matter of concern to note that this level has been on the decline since the beginning of the Tenth Finance Commission when it touched a factor of 2.976, and then fell to 2.643 for the Eleventh Finance Commission and further down to 2.439 for the Twelfth Finance Commission. The value of this index went further down to 2.111 for the Thirteenth Finance Commission. These variations are drastic in being disadvantageous to the group of Special Category States. Whereas the elements involved in the formula for tax sharing may not be generally questionable, but the weightage given to area has a certain infirmity in the design. The disability factor for the mountain areas has not been taken into cognizance at all.  In the area weightage, the States of Goa, Haryana, Himachal Pradesh, Kerala, Manipur, Meghalaya, Mizoram, Nagaland, Punjab, Sikkim, Tripura and Uttarakhand have been given an identical weight of 2 per cent. It is generally understood that the Special Category States are obliged to incur a higher per capita expenditure on provision of general administration as well as developmental services due to geographical disadvantages and sparseness of the population. An indicative measure of this aspect will be the proportion of the revenue deficit grants provided by the successive Finance Commissions to the total devolution because the revenue deficit grants are viewed as a mechanism to equate the Special Category States with the other States as regards the expenditure requirements to have basic minimum semblance of administration and to some extent, the developmental services.

8.      We may now look at the composition of the gross devolution to the Special Category States. Since the major financing of the devolution is met by the share in central taxes, we may compare the proportion of the devolution by share in central taxes to the gross devolution over the study period. The data in this behalf is contained in the subjoined table:-

Commission period              Gross devolution       Of which share           Col. 3 as
in central taxes             % of 2

SFC (1997-84)                      2026.07                     918.74                        45.3

EFC (1984-89)                      5545.50                   3809.29                        68.7

NFC (1989-90)                     2260.14                   1238.97                        54.8

TFC (1995-2000)                34372.77                 27780.82                        80.8

9.         The above data clearly reveals that successive Finance Commissions have tended to meet the assessed transfers by an ever increasing proportion through the mechanism of share in central taxes up to the award of the Tenth Finance Commission. This was a positive trend in the sense that tax devolution affords a certain element of buoyancy vis-à-vis the static situation of the gap filling grants. But this trend was reversed from the beginning of the Eleventh Finance Commission till the end of the Twelfth Finance Commission. The Thirteenth Finance Commission has again moved on the progressive path by meeting nearly two-thirds of the total transfers through the tax sharing mechanism. As the economy grows, the tax collections are likely to be more buoyant than in the past leading to increase in the amount of resources through this constitutional provision.

10.       We may now come to the share of individual States in the gross devolution through the successive Finance Commissions along with the share in central taxes. The data is presented in the following table:-

11.         Actual data in the above context is appended as Annexure I to this paper. Whereas the data for the Seventh, Eighth and Interim award of the Ninth Finance Commission tenures has been included and analysed above for historical purposes, it would be of interest to look at the comparative position of the Ninth and the Tenth Finance Commission awards. The shifts in percentage shares in the aggregate devolution and the share in central taxes for these two award periods are depicted in the following table:-

12.       It may be seen that in the terms of gross devolution, Assam, Mizoram, Manipur and Tripura had a decline in their share during the Tenth Finance Commission period as compared to the Ninth Finance Commission period. All other States gained in share in gross devolution and the gain was highest in the case of Himachal Pradesh. In terms of the share in central taxes, Mizoram was only State which had a decline in the Tenth Finance Commission award vis-à-vis the Ninth Finance Commission award.  All other States had an improvement in the share in central taxes at an overall level in the dispensation of the Tenth Finance Commission as compared to the Ninth Finance Commission one. In this case also, Himachal Pradesh was the biggest gainer, followed by Jammu and Kashmir.

13.        Similar comparison between the awards of the Tenth FC and Eleventh FC is presented in the following table:-

14.       It is obvious from the above data that gross devolution to Special Category States under the award of the Eleventh Finance Commission showed a drastic decline in all cases except the two States of Jammu & Kashmir and Sikkim. At an overall level, the gross devolution to all Special Category States put together vis-à-vis the gross devolution to all States stood at 13.44 per cent under the award of Eleventh Finance Commission. This was 15.16 per cent in the Tenth Finance Commission and 14.96 per cent in the Ninth Finance Commission. In the context of the rising trend in the past, the Eleventh Finance Commission award could be perceived as a poor deal to the Special Category States. When one looks at the devolution through the share in central taxes, a significant decline is visible   at an overall level (7.30 per cent under Eleventh Finance Commission against 13.46 per cent under Tenth Finance Commission) as also in the case of each Special Category State. This enlargement of the pool of shareable taxes does not appear to have worked progressively for the Special Category States due to such a massive decline in the tax share to all these States put together. In that, the tax sharing scheme has been adverse.

15.       The comparative data on gross devolution and the devolution through the tax sharing mechanism for the award period of the 12^th Finance Commission vis-à-vis the 11^th Finance Commission and the shifts are presented in the subjoined table:-

16.      The data reveals that in terms of the total devolution Assam, Himachal Pradesh, Jammu and Kashmir, Mizoram and Tripura had an improvement in their share for the award period of the 12^th Finance Commission as against that of the Eleventh Finance Commission. In the design of tax sharing adopted by the Twelfth Finance Commission, Assam, Himachal Pradesh, Jammu and Kashmir and Tripura had a fall in their shares vis-à-vis the Eleventh Finance Commission award.

17.       The comparative data on gross evolution and the devolution through the tax sharing for the award period of the 13^th Finance Commission vis-à-vis the 12^th Finance Commission and the shifts are presented in the subjoined table:-

18.     The data reveals that in terms of the total devolution, the States of Arunachal Pradesh, Assam and Sikkim had an improvement in their share for the award period of the 13^th Finance Commission as against that of the 12th Finance Commission. In the design of tax sharing adopted by the Thirteenth Finance Commission, all the Special Category States have had an increase in their shares vis-à-vis the Twelfth Finance Commission award. Assam has been the biggest gainer in this dispensation followed by the States of Himachal Pradesh, Jammu and Kashmir and Uttarakhand. The decline in the overall devolution in the case of Himachal Pradesh, Uttarakhand and Jammu and Kashmir should not be viewed as adverse dispensation since these States hold promise in the area of their own revenue generation which inevitably leads to comparatively smaller devolution on account of the revenue deficit grants. In the case of Himachal Pradesh, large incrementality in their own revenues from power sector and massive growth in the sales tax revenues have led to a comparatively smaller devolution in the nature of revenue deficit grants. It would not be correct to view the reduction in the level of the Revenue deficit grants as compared to the Twelfth Finance Commission dispensation in isolation without taking cognizance of the increased own revenues of the State.

19.       According to the award of the Eleventh Finance Commission, of the total vertical devolution of central taxes, the Special Category States accounted for 7.30 per cent, whereas the corresponding percentage for the award period of the Twelfth Finance Commission is 8.09 per cent. In that perspective, one could conclude that the improvement is due to addition of one State, namely Uttarakhand which increased the population share for all Special Category States to 5.912 per cent from 5.084 per cent and that of the area from 16.485 per cent to 18.117 per cent of the all-India figures. For the Thirteenth Finance Commission award period, the share of the Special Category States put together in the share of central taxes is 9.44 per cent against the corresponding figure of 8.09 per cent for the Twelfth Commission period. This is truly an increase about which no Special Category State should have any misgivings. The Thirteenth Finance Commission has certainly moved in enhancing equity among the Special and non-Special Category States.

20.       This comment on the tax sharing design should also be seen in conjunction with the revenue deficit grants. A brief view of history in this behalf will be of interest. The revenue deficit grants are used to bridge the gap between the assessed levels of expenditure commitments and the own revenues topped with the tax shares of individual States. The data is presented in the following table:-

21.       The above data provides an interesting insight into the pattern of provision of the revenue deficit grants to the States for meeting the non-plan expenditure commitments beyond their own revenues and the share in central taxes. The Special Category States have figured in the award periods of all the Finance Commissions. The number of States becoming eligible for the revenue deficit grants really ballooned during the full period award of the Ninth Finance Commission when 21 States had to be provided non-plan revenue deficit grants. Since then, this number has shown a gradual decline all the way through. So much so, the number of States which will receive revenue deficit grant during the award period of the Thirteenth Finance Commission has now come down to only 8 Special Category States. Three Special Category States namely, Assam, Sikkim and Uttarakhand do not need revenue deficit grants since their expenditure commitments stand met with the tax sharing design. This indicates clearly that even the Special Category States are arriving on the platform of “being on their own” post tax-sharing, which is a constitutional due.

22.       Prior to the award of the Eleventh Finance Commission, the structure of tax sharing was different from the one which came into force at the time of the award of the Eleventh Finance Commission. The Constitution has been amended to provide for all taxes/duties becoming shareable now and the vertical devolution provided for a fixed 29.5 per cent vertical devolution to all States for the period of the Twelfth Finance Commission, the vertical devolution constitutes 30.5 per cent of the shareable pool. The Thirteenth Finance Commission has raised the share of the States by way of vertical devolution to 32 per cent and this has led to the States getting emancipated from the syndrome of revenue deficit grants. This bodes well for the health and resilience of the federal fiscal system in India. As mentioned above, three Special Category States namely Assam, Sikkim and Uttarakhand have become able to meet their non-plan revenue expenditure through their own revenues and the share in central taxes. The data on own revenues, non-plan revenue expenditure and the tax shares of the special category States as assesses by the Thirteenth Finance Commission is presented in the following table:-

(Rs. crore)

Note : The numbers may not tally due to rounding

23.       The above data clearly reveals that the three revenue account surplus States among the Special Category States can use this surplus fort accelerating their developmental effort. Prudent developmental spending can further lead to better revenue generation in the times to come and make these States fiscally self-reliant, reducing their leaning on the Central Government for developmental funding.  It is very important to mention here that there are nine States in the country which have a revenue account surplus as assessed by the Thirteenth Finance Commission even with their own revenue effort and these include Andhra Pradesh, Chhattisgarh, Goa, Gujarat, Haryana, Karnataka, Maharashtra, Punjab and Tamil Nadu. The entire chare of central taxes allocated to these nine States is available to these States as investible surplus besides their own revenue account surplus. This is the ideal situation towards which all States of the country should move.

24.       Before closing this spectrum of analysis, it would be of academic interest to see the variation between the forecast made by various Special category States as to their expenditure and own revenue as against the levels assessed by the Thirteenth Finance Commission. The comparative data in this regard is depicted in the following table:-

(Rs. crore)

25.       It may be observed from the above table that as regards the assessment of the own revenues of the States, the Thirteenth Finance Commission improved upon the State forecast in the case of Arunachal Pradesh, Assam, Himachal Pradesh, Meghalaya, Mizoram, Sikkim and Tripura; whereas for the remaining States, the States’ forecast of their own revenues was higher as compared to the assessment made by the Thirteenth Finance Commission. These variations do not indicate any method in the madness of assessment by either. However, since the assessment by the Finance Commission is based upon the Standard Tax : GSDP ratio, one would tend to agree more with this assessment. As regards the non-plan revenue expenditure, with the exception of Arunachal Pradesh where the assessment by the Finance Commission is higher than the State forecast, the expenditure projections by all States are much higher than the Assessment made by the Thirteenth Finance Commission.

26.       In the context of Himachal Pradesh, one has been hearing rumblings from various political outfits and the government side about the raw deal or unfair award given to the State by the Thirteenth Finance Commission. To make a comment about it, it is imperative that one studies the data which is available through the report of the Thirteenth Finance Commission.  The comparative picture on the forecast submitted by the State Government and the assessment made by the Thirteenth Finance Commission for Himachal Pradesh for the period 2010-15 is depicted in the sub-joined table:-

(Rs. crore)

* : The other expenditure includes Salaries, expenditure on general, social and economic services to be met through the non-plan spending, assignments to local bodies and expenditure on committed liabilities.

Note : The numbers may not exactly tally due to rounding.

27.       A careful look into the figures in the above table indicates that there is hardly any significant variation in the assessment of revenue receipts between the forecast projected by the State Government and the assessment made by the Finance Commission despite the fact that the Commission proceeded to do the assessment based on definitive normative considerations. The State Government had used the historical methodology to generate the forecast whereas the Finance Commission has linked the revenue receipts to the projected growth in the State Domestic Product. The variations, however, are large and significant on the expenditure side. It would be prudent to look at the methodology used by the Finance Commission to estimate the expenditure side inputs. The Finance Commission has used the following methodology for estimating the major components of the expenditure across the board for all States:

• Finance Commission assumed that the States have implemented the revised pay scales from 1.4.2009 with retrospective effect from 1.1.2006. Therefore, the budget estimates of the year 2009-10 were used by the Finance Commission to build salary expenditure into the forecast period.

• The Commission has used one time increase of the order of 35 per cent in the salary expenditure for 2006-07. Thereafter, it provided 6 per cent per annum growth after taking into account 3 per cent annual increment, 6 per cent dearness allowance and 1 per cent attrition. The salary expenditures for the central and the State Government employees have been projected on this basis for the period 2006-10.

• Expenditure on the salaries of the local bodies employees has also been added to the expenditure base for forecasting it into the 2010-15 period.

• The Finance Commission has limited the impact of pay revision to salary expenditure to a ceiling of 35 per cent of the total revenue expenditure and the expenditure over and above this ceiling has been successively reduced by 10 per cent of the amount every year.

• For the expenditure on pensions, the Commission has worked out the impact on State pensions to be higher by 21 per cent over the 2008-09 pension expenditure which was arrived at by applying the trend growth rate over the actuals of pension expenditure for 2007-08. Pension expenditure post-2009-10 has been projected to grow at 10 per cent per annum.

• Interest payments have been projected on the basis of the debt stock indicated in the fiscal reform path framed by the Commission. For the years 2008-09 and 2009-10, the lower of the revised estimates or 3.5 per cent of the GSDP and Budget Estimates or 4 per cent of the GSDP, respectively, has been taken as the fiscal deficit for projection of the debt stock.

The above assumptions are basically responsible for the vast difference between the forecast made by the State Government and the assessment made by the Finance Commission. Since the Commission has used uniform methodology for all the States, there is precious little ground for any individual State to hold out a grudge against the dispensation worked out by the Finance Commission. The most critical input into the assessment methodology is the data presented by the State Government while presenting the budget for the year 2009-10 because the Commission methodology leans on entirely on the Budget Estimates for the year 2009-10 for the purposes of the salary expenditure. Hence the salary expenditure in the Budget Estimates had to be close to the number after taking into account the impact of pay revision. The difference would be known after the actual expenditure figures for 2009-10 come in. The most important aspect of the devolution design is the share in central taxes for individual States. In that Himachal Pradesh is a gainer as its share has risen from 0.68 per cent for the tenure of the Twelfth Finance Commission to 0.78 per cent during the tenure of the Thirteenth Finance Commission.

 

This is against about 0.6 per cent population share of the country. This increase is salutary keeping in view the fact that the vertical devolution has also gone up from 30.5 per cent to 32 per cent for the corresponding award tenures. The increase in share represents a growth of 14.7 per cent on the share to share basis. Add to that the increase in the vertical devolution which is of the order of 4.92 per cent.  The two growth rates after being compounded give an increase of the order of 20.3 per cent. This implies that the share in central taxes for Himachal Pradesh during the award period of the Thirteenth Finance Commission is a quantum increase as compared to the earlier Finance Commissions. When the own tax and non-tax revenues of the State show a significant increase and the share in central taxes is a better deal than in the past, it is implicit that the revenue deficit grants are likely to decline. One should always look at the complete picture rather than viewing it selectively in the context of reduced revenue deficit grants and attempt to make a mountain out of a mole hill. The meaning of the revenue deficit grants should be clearly understood to be the unfilled gap between the total non-plan revenue expenditure on the one hand, and the total tax and non-tax revenues inclusive of the share in the central taxes , on the other.