At the end of October the
government announced the terms of reference of the Twelfth Finance
Commission (TFC), which is to be headed by the Andhra Pradesh Governor
and former governor of the Reserve Bank of India, Dr. C. Rangarajan. The
Commission is supposed to submit its final report by July 2004 so that
the government could incorporate the recommendations in the Budget for
2005-06. While Dr Rangarajan is the chairman, the members include
Planning Commission member Som Pal, former cabinet secretary T R Prasad
and D K Srivastava of National Institute of Public Finance and Policy.
As has been the case with most economic announcements in recent times,
the terms of reference of the newly constituted TFC have not invited
much comment, even though they reflect a further widening of the
conventional mandate of a Finance Commission and presage a process in
which state governments are forced to go along with the neo-liberal
reform agenda of the central government. Speaking to the press soon
after the Union Cabinet cleared the terms of reference, Finance
Secretary S. Narayan reportedly said that: "As compared to the terms of
reference of the 11th Finance Commission, the terms of the 12th
Commission lays emphasis on certain efficiency factors such as
adjustment of user charges, relinquishing non-priority enterprises
through privatisation or disinvestment and resource mobilisation to
improve the tax-GDP ratio." This can only be taken to mean that a
state's access to resources would be linked to its willingness to raise
user charges for the public services it provides, disinvest the
enterprises it owns and impose new taxes to raise revenues and cover
more of its expenditures.
Conventionally, the Finance Commission is concerned with the criteria
that should govern distribution of taxes between the Centre and the
states and among the states themselves. The evolving mandate of
Commissions constituted in the past has essentially sought to address
two issues. First, it recognised the fact that in a federal system, the
ability of government at different levels to raise revenues through
taxation is unlikely to match the responsibilities shouldered and
therefore the expenditures undertaken at those levels. Hence the Finance
Commissions were mandated with determning the vertical sharing of Union
taxes between the Centre and the states. Second, in order to reduce the
large inter-state disparities, which would widen if a state's access to
resources was determined purely by its GDP, it provided for the
construction of a formula that would prevent poorer states from being
trapped in their underdevelopment by providing a weight for backwardness
in the determination of revenue shares.
Despite these safeguards, neither have the states been able to obtain
adequate resources to finance their expenditures, nor has inter-state
disparity been reduced substantially. While inadequate resources
mobilisation and unnecessary expenditures at the state level have
contributed to the financial difficulties confronted by the state,
central policies have played a major role in generating a fiscal crisis
at the state level. For example, it has been observed that the centre
has over time sought to increase the share of non-sharable revenue
sources (such as surcharges) in its total revenues, adversely affecting
the states. Further, neo-liberal reform has affected the states in two
ways. Stabilisation policies adopted in the early 1990s had raised
domestic interest rates substantially. The larger outgo on account of
interest payments meant that the states had to increase the volume of
debt incurred by them. This has reached a situattion where today the
restructuring of state-level debt, by replacing high-cost with low-cost
debt, is seen as an important means to resolve the fiscal crisis at the
state level. In addtion, direct and indirect tax concessions provided by
the Centre as part of neo-liberal reform, in order to spur private
initiative, have led to a signficant decline in the central tax-GDP
ration, which affects the states adversely as well. Not surprisingly,
states that were recording revenue surpluses till the late 1980s,
witness their transformation into deficits and experienced a sharp
increase in those through the 1990s.
More recently, the erosion of resources available to the states has led
up to a crisis because of the implementation of the Fifth Pay
Commission's recommendations. The impact of those recommendations, which
states were forced to adopt once they were implemented at the central
level, was that the ratio of salaries and wages to the revenue receipts
of the states, which had been going down till 1996-97, rose dramatically
and almost doubled after 1997-98. In the event, the gross fiscal deficit
of states which was below 3 per cent of GDP during much of the 1990s
shot up to 5 per cent by 1999-2000. With this growing role of debt in
financing expenditures the outstanding debt of all state governments,
more than doubled from Rs 243,000 crore in March 1997 to about Rs
500,000 crore in March 2001. This massive increase in debt had as its
corollary a more than six-fold increase in the interest liability of all
states over the 1990s, from less than Rs 9,000 crore to more than Rs
54,000 crore.
Overall the states' debt to GDP ratio, which was over 19 per cent in the
early 1990s, but came down to under 18 per cent by 1996-97, rose to
about 23 per cent in the four years ending with 2000-01. We must also
note that the revenue deficit, or the excess of current expenditures
over revenues, which accounted for less than 30 per cent of the gross
fiscal deficit of the states in the early 1990s, rose to 60 per cent by
the end of the decade. This implies that nearly two-thirds of the debt
incurred by the states is now being used to finance current expenditure.
As mentioned earlier, in an ostensibly cooperative effort between the
centre and the states to resolve this problem, the high-powered
committee on state finances, chaired by Finance Minister Jaswant Singh,
is mooting a debt-swap mechanism, involving the replacement of high with
low cost debt, as a solution. This together with the move to replace
sales tax with VAT at the state level is being viewed with suspicion by
the states.
The grounds for suspicion are strong, given the evidence that the centre
is seeking to use the fiscal problems of the states, which have been
partly created by the former, to force the latter to adopt controversial
neo-liberal policies. In the past this was being done through means
other than conditions attached to what are constitutionally warranted
statutory transfers of resources to the states. One such means was was
to use the mechanism of non-statutory transfers to the states,
principally through the Planning Commission, to force unpopular policies
on the states. The other was to encourage state governments to approach
agencies like the Asian Development Bank and the World Bank for project
funding, in return for which they demand a restructuring of finances by
the states. This was what has happened in cases like Orissa and Andhra
Pradesh and is currently underway in Kerala. It also was a reason for
controversy in the state of West Bengal.
But starting with the Eleventh Finance Commission, the effort to force
the states into accepting neo-liberal reform policies has involved
making suitable additions to the original mandate for such Commissions
laid down in the constitution. Thus, the Presidential Order of April 28,
2000, had asked the Eleventh Finance Commission ``to draw a monitorable
fiscal reforms programme aimed at reduction of revenue deficit of the
States and recommend the manner in which the grants to States to cover
the assessed deficit on their non-Plan revenue account may be linked to
progress in implementing the programme.''
Thus the Eleventh Commission was asked to include the formulation of a
fiscal reform programme in its terms of reference. By doing so the
Centre was not merely seeking to give a particular kind of "fiscal
reform" constitutional validity, but asking the commission to give the
centre the right to use provision of assistance to cover non-Plan
revenue deficitis as an instrument to enforce compliance with such a
reform programme. Not surprisingly, many states, led by the Government
of Kerala had expressed strong reservations about the addition terms of
reference.
Now the Centre has gone even further. To start with, the TFC has once
again been asked to suggest a plan to restructure public finances to
restore budgetary balance and macro economic stability and reduce the
debt burden. In addition, as stated earlier it has been required to
provide weightage to a state's willingness to implement "reform"
policies such as raising user charges, privatise and reduce the tax-GDP
ratio when determining its access to a constitutionally guaranteed share
in resources. Further, to ensure that this effort at strapping the
states into the reform process would be successful, this time around the
government has decided to give the Planning Commission a role in
influencing the devolution formula and the conditionalities to be
associated with the provision of a share to the states in central
resources. Clearly Planning Commission member Sompal is an "ex-officio"
nominee to the Finance Commission, and is likely to ensure this role for
the body which hitherto could only use non-statutory transfers as a
means of pushing the central agenda at the state level.
This attempt to use the Finance Commission to push through what is the
real thrust of the so-called "second-generation" of reforms, namely, the
enforced adoption of reform polices in a host of areas which fall within
the jurisdiction of the states and not the centre, is clearly a
violation of the conbstituional mandate in this regard. Article 280
Clause (1) of the Constitution of India provides for a statutory Finance
Commission, being set up every five years, to recommend the rules that
should govern the devolution of funds from Centre to the states and
their distribution among the states. The choice of a five year life-span
for the recommendations of any single Commission implies that those who
framed the Constitution wanted changes in the economic structure that
occur with development to be taken account of when formulating
devolution rules. However, using the Finance Commission, which is a
constitutional instrument, as an agency to push through a highly
controversial change in the economic policy regime is clearly a breach
of its constitutional obligation by the Centre. Using the Planning
Commission, which is an administrative body, to implement this
subversion of the work of a constitutional institution such as the
Finance Commission is an even greater violation. It is imperative that
the states challenge the Centre's manoeuvres in this regard, so as to
protect the freedom provided by the Constitution to frame their own
policies in areas identified as being within their jurisdiction.
