Indian Fiscal Federalism, Speech of Shri N.K. Singh, Chairman, XVFC at the launch of the book

Following are the highlights of the speech of Shri N.K. Singh, Chairman, 15th Finance Commission, at the launch of the book “Indian Fiscal Federalism” written by Dr. Y. V. Reddy, former Governor of RBI and Chairman of the 14th Finance Commission of India alongwith Dr. G. R. Reddy, Advisor (Finance) to the Government of Telangana:

I agree with him that Fiscal Federalism is a dynamic process so to say ‘a Work in Motion.’

(Page 12) “It is useful to note that the Finance Commission as envisaged in the Constitution does not prohibit its continuous functioning except that it has to be re-constituted before the expiry of every 5 years.” There is a need for recourse mechanism for mid-term correction, similar to Australian Model of continuous Grants Commission ‘state relativities’ are revisited every years based on latest available data. If macro parameters go along should the tyranny of the Finance Commission be inflicted on the States for 5 years before any relief can be corrected? After all, all awards of the Finance Commission are based on realistic assumptions on what is acceptable macro-economic model in terms of key parameters like revenue projections, State GDP growth, permissible expenditure growth etc. Indeed in our visits to many States we did encounter that in some States the revenue projections were unrealistic, the expenditure suppression was unacceptable and the State GDP numbers look quite misaligned. So what is the recourse mechanism for States or Union may have in case it is found that in the vertical devolution there are also lacunae of one kind or another. Should that wait for a 5 year correction or should there be midterm recourse.

(Page 13) “There were also serious concerns about the role of the Planning Commissions in governance at the Union level and in Union-State Relations. There were apprehensions that it would be an extra Constitutional authority. Some felt that any financial transfer outside the Finance Commission was not envisaged in the Constitution.”

Indeed on Page 14 in the book para 4 last line it says “ from the 4th Finance Commission the TOR in the presidential order appointing the Commission excluded the consideration of the Plan requirements of the State by the Finance Commission, and the Planning Commission became an important parallel channel of transfers.” Several Finance Commissions in the past have lamented at their constitutional role being circumscribed in being excluded from the consideration of the Plan requirements. Now that the Planning Commission does not exist and this remorse cannot be expressed what is the institutional mechanism which can make up the lament of the past. This inhibition of the Finance Commission in the plan requirements of the States does not exist anymore, particularly since the NITI Aayog itself, in the words of the authors at page 16, has more of an advisory mandate. Altering the role of the NITI Aayog, policy makers would be mindful of the need of not to create a Planning Commission version 2.0 since it was a conscious decision not to accord resource allocation powers to NITI Aayog. Should one not be careful of creating another parallel financial transfer mechanism?

The Original Sin

The 7th schedule of the Constitution based on Art 246 of the Constitution clearly lays down the subjects for the Union List, the concurrent list and the State List with the exception that each will respect so to say the territorial limits of the other. The authors on page 22 have an interesting section entitled “Era of entitlement–based central legislations”. The examples given are the Mahatma Gandhi National Rural Employment Guarantee Act of 2005, the Right of Children to Free and Compulsory Education Act 2009 and the National Food Security Act 2013. How do these stand-alone entitlement legislations mesh with the 7th schedule of the Constitution and transgress the borders? And how could that none of the States, much less those with domain knowledge, did not oppose at the transgression of these limits? The authors correctly pointed also on para 2 of page 76 that “Over the years there has been an enlargement of the Concurrent List and the Centre’s spending on State Subjects presumably on the grounds that such expenditure will serve national priorities better.”

The autonomy of the State, if one were to use that expression, was severely circumscribed the moment they become a party to and indeed voted for the constitutional amendments enlarging not only the Concurrent List but enlargement in the Central government spending on State governments subject has correctly pointed out by the authors. This has also complicated the drawing board immensely as one looks at the overall picture. 

In dealing with the policy space for the Union and the States on page 76 of the book the authors observed that the transfers through the Centrally Sponsored Schemes (CSS) impose heavy burden on the State governments. First through the sharing pattern, second on schemes where they have to readjust or adapt their own schemes with conditions imposed by the Central government and third, by forcing to modify or roll them back because of resource concerns. “Above all, despite using the State administrative machinery and contributing to the schemes while accepting the priorities of the Centre, the credit for the whole programme is taken by the Government of India.” 

Centrally Sponsored Schemes (CSS) were first initiated even before the First Plan started and during the period of interim Finance Commission by giving central grants for a scheme like Grow More Food Scheme. In the First Five Year plan, many schemes in the states’ domain were funded through central grants like Damodar Valley, Bhakra Nangal, many community development projects, minor irrigation schemes etc. And so to say this was the original sin in which the forbidden fruit was consumed by both the Center and States and there is no redemption thereafter. The authors correctly point out concerns on page 77 that “the most sensitive part of Centre-State fiscal relations is mainly the area of transfers outside the Finance Commission that is implicitly available to the Centre. The States feel that the magnitude of the transfer are large; their inter-state distribution is discretionary, arbitrary, and regressive; the transfers create multiplier responsibilities on them; that they distort the designs of the State schemes even if the later are better and more advanced; and above all, the entire credit is taken by the Central Government, whereas the schemes are jointly funded and implementation is done exclusively by the States.” What is the basis of the perpetuation of this original sin? The Central Government does not even transfer the subjects related to the CSS to the Concurrent list or have individual standalone legislations instead securing parliamentary power.

Catch-22 between Art. 282 and Seventh Schedule

Note the Article 282 of the constitution which says “The Union or a State may make any grants for any public purpose, notwithstanding that the purpose is not one with respect to which Parliament or the Legislature of the State, as the case may be, may make laws.”

Originally in the Constitution, it was not expected to be an overarching provision but an extra-ordinary one to be used very sparingly used. And If I quote Shri K Santhanam, Chairman of the 2nd Finance Commission on Article 282, he said- “This was not intended to be one of the major provisions for making readjustments between the Union and the States, if that was the idea, then there was no purpose in evolving such a complicated set of relations of shares, assignments and grants. There is no purpose in having two Articles enabling the Center to assist the states-one through the Finance Commission and the other by more executive discretion. In the latter case, even parliamentary legislation is not needed. Of course, it will have to be included in the Budget. But, beyond being an item in the Budget, no further sanction need to be taken. Therefore, in my view, this Article was a residuary a reserve Article to enable the Union to deal with unforeseen contingencies. That was how this Article was used both by the British Government and, after transfer of power, before the first year of the First Five Year Plan. Under this Article, only some grow-more-food grants and some rehabilitation grants were given.”

And N A Palkhivala, Constitutional expert, in his opinion given to 9th Finance Commission, opined- ”Art.282 is not intended to enable the Union to make such grants as fall properly under Art. 275. Art. 282 embodies merely a residuary power which enables the Union or a State to make any grant for any purpose, irrespective of the question whether the purpose is one over which the grantor has legislative power.”

For how long the misuse of the Article 282, totally outside the frames of the constitution, will continue to exist? This is the core question that creates dichotomy in the functions of the Finance Commission as envisaged in Article 280. How is this contradiction to be resolved? This requires wider debate.

Triumph of Experience over Expectations

Finally a final comment is about the Triumph of Experience over Expectations. While justifying the 42% devolution recommended by the 14th Finance Commission on page 74 of the book the authors very correctly point out that tax devolutions of 42% recommended by the 14th Finance Commission is not comparable with devolution of 32% recommended by its immediate predecessor. The tax devolution the Commission recommended subsumed normal plan assistance, special plan assistance, special central assistance and also state-specific grants. In addition it did not recommend any sector-specific grants. In almost every state which we visited there was complaint by the States that in some ways funding mechanism to give back what they thought as lost money have been subsumed under the award of the Finance Commission. Going beyond this the rationalisation of the CSS and circumscribing the transfers outside the formal mechanism by recourse of Act 282 also remain more or less where it was prior to abolition of Planning Commission. The experience seem to have triumphed over expectations. 

As we go forward there is a Chapter in this book pertaining to the Fifteenth Finance Commission and I must make one or two observations. This chapter analyses in detail the wording of the Terms of Reference of the Fifteenth Finance Commission and is problematic in several ways and that the wording seem to be just predilection in favour of the Union and gives us sound advice in its concluding paragraphs that going by the stand taken by the previous Finance Commissions, the XV Finance Commission is not bound by all the conditions listed out in the TOR. Hoping “that it would have the courage and wisdom to be guided by the letter and spirit of the Constitutional provisions in discharging its responsibilities and upholding the sanctity of the institution.”

I do not wish to comment too much on this except to say that it is the President’s prerogative to determine both the wording and the context of the TOR assigned to the Commission. And it is the prerogative of the Commission to address them in a manner that it considers appropriate. The Commission is not obliged to agree but the Commission is obliged to address the specific reference which have been made to it. In doing so we are inherently bound by past precedence and the contours of our constitutional obligations. 

Never too Late

I think Article 282 of the Constitution needs to be circumscribed and prescribed some conditions which can be invoked for undertaking schemes and measures which can undercut the basic functioning of the transfer mechanism through the Finance Commission. Indeed, in the history of the Finance Commission, the extra constitutional comfort of the Planning Commission in undertaking several of these transfers by recourse of art 282 is part of this original sin. We do not have a way forward.

There are one or two other areas which the book has referred to where it is so to say, functionally work is in progress, namely in the terms of Cesses & surcharges becoming a disproportionate proportion of the overall divisible revenue, non-tax revenues being kept outside the divisible pool. These are no doubt worrisome issues because I too agree that there should be some mechanism to ensure that the basic spirit of the devolution process should not be undercut by clever financial engineering or taking recourse to traditions which makes them technical and legally tenable but perhaps morally not so.

I also like to draw the attention to the consolidated fiscal roadmap for Centre and States where we have entered the era of competitive fiscal profligacy by use of Art. 282 by both Centre and states. However, rules of the game should be same for both. For state government liabilities, Article 293 (3) provides a constitutional check over borrowings. But there are no such restriction on the Centre. I feel that it is time we have an alternative institutional mechanism like Fiscal Council to enforce fiscal rules and keep a check on Centre’s fiscal consolidation.”