Themes > Current Issues
10.11.2002
Twelfth Finance Commission: Dangerously Widening Mandate
C.P.
Chandrasekhar
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.
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.
© MACROSCAN 2002