Fiscal federalism needs to be considered by the 16th Finance Commission

First, there is the intersecting area of ​​the Finance Commission and the Goods and Services Tax (GST) Council. The latter’s decisions affect the states’ own tax revenue flow and, more importantly, the size of the central tax revenue pool, which is to be shared between the central and state governments as per the recommendations of the Finance Commissions. Clearly, the Finance Commission’s estimates of state and central tax revenues and recommendations based on them will be influenced by the decisions taken by the GST Council. This was a major concern during the 15th FC deliberations when GST revenue was highly volatile, GST administration was still unstabilised, and the GST Network IT platform was still problematic, especially for e-way bill preparation. This has greatly amplified the challenges that the 15th FC was facing in estimating revenue as the economy witnessed an unprecedented contraction in 2020-21 in the wake of the COVID pandemic. Fortunately, most of these problems have been resolved and GST has now emerged as a big and good source of revenue for both the Center and the States.

Recent calls for greater centralization of spending assignments are another issue. India has a semi-federal system. For the purposes of legislation, regulation and administration, Schedule 7 of the Constitution specifies 97 subjects in the Union List, which includes all major subjects relating to national security, external relations, union finance, banking, foreign trade and major infrastructure. Another 66 subjects are assigned to the State List and 47 subjects to the Concurrent List. But in case of difference of opinion between a State or States and the Union for the subjects of the Concurrent List, the view of the latter shall be conclusive. Similarly, if there is a conflict between Union and State legislation, the Central law will prevail. Finally, even for state subjects, the central government can and does intervene through centrally sponsored schemes, in which it encourages states to adopt centrally selected schemes by funding a part of the cost of these programmes. Is.

The case for further centralization of this quasi-federal system rests mainly on economic considerations. The analytical literature has long established that private benefits are maximized when the jurisdictional assignment of a subject closely matches the spatial benefit spread of public interventions under the subject. However, private profit maximization has to be set against the potential cost savings from economies of large scale and lower transaction costs with greater centralization. In addition, there is also the issue of externalities. If the social benefit or harm may extend beyond the boundaries of the lower level jurisdiction, it requires the subject matter to be delegated to a higher level jurisdiction with wider spatial coverage. Finally, equity considerations may require greater centralization to enable the provision of comparable levels of public or merit services to all citizens in a country.

These economic arguments for greater centralization must be seen in the context of larger political ideas and the distribution of political power at different levels of government. This question became important when non-Congress parties came to power in several states in the late 1960s demanding greater decentralisation. It is again a major political issue today, with non-Bharatiya Janata Party governments in power in many states. A change in the assignment of subjects under Schedule 7, whether towards greater centralization or towards greater decentralisation, would require a constitutional amendment. How this happens will largely depend on the political profile of the country after the 2024 general elections.

Another issue is the third tier of government. Although the Constitution mentions the importance of local governments and Panchayati Raj institutions, it has left it to the states to decide which functions from the state list in the 7th Schedule should be further devolved to local governments. Subsequently, the 73rd and 74th Constitutional Amendments specified a detailed list of subjects that should be assigned to Panchayati Raj Institutions (PRIs) and Urban Local Bodies (ULBs), respectively. But once again, it was left to the state legislatures to decide what functions, funds and functionaries should be assigned to PRIs and ULBs. Not surprisingly, little progress has been made on such work in most states, as it would empower elected PRIs and ULB representatives at the expense of state legislatures. State governments also correctly point out that it is difficult to transfer functions to PRIs and ULBs, whose capacities are generally very low. However, the capacity of these institutions cannot be strengthened unless they are provided with the resources to build such capacity. It is a ‘chicken and egg’ problem. To help break this conundrum, the 13th, 14th and 15th FCs have attempted in different ways to ensure adequate fund flow to PRIs and ULBs.

13th FC Chairman Vijay Kelkar suggested that a consolidated fund should be created for PRIs and ULBs, funded by earmarking a share of Central GST and State GST for them.

So far, except in one or two states, there have been no serious reforms to empower the third tier of government. However, if the electoral success of legislators at the state level depends on empowering elected representatives in PRIs and ULBs, it could set in motion an entirely different political dynamic. Bottom-up dependence may gradually replace the prevailing system of political patronage from top to bottom.

These are the personal views of the author.

Sudipto Mundle is the chairman of the Center for Development Studies.

Updated: June 29, 2023, 11:13 PM IST