The recent protests by Southern state governments, notably Kerala and Karnataka, supported by other non-Bharatiya Janata Party-ruled states, have highlighted concerns regarding fiscal federalism in India.
Fiscal federalism is concerned with understanding which functions and instruments are best centralised and which are best placed in the sphere of decentralised levels of government. It involves vertical and horizontal dimensions.
Within the domain of vertical devolution, which includes sharing of resources between the Union and states, there are two disturbing trends that need urgent redressal, as argued by professor R. Ramakumar.
Don’t miss this data-backed, lucid, and important analysis in The Hindu by Professor R. Ramakumar of how States are done out of their rightful share of the net divisible pool of revenues by the Union government and how the practice of fiscal federalism in India is deeply flawed. pic.twitter.com/lBTuPNR7Fw
— N. Ram (@nramind) February 29, 2024
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Ramakumar argues that the Union government is keeping more of its earnings out of the divisible pool to avoid sharing with states. It’s also not devolving the share of net proceeds to the states, as mandated by successive Finance Commissions.
Central taxes that are shared with states go into a divisible pool, while cesses and surcharges are excluded. The share of the latter has increased from around 10% in 2011-12 to as much as 25% in 2021-22.
However, the increase in the size of the tax kitty owing to cesses and surcharges is being appropriated by the Centre via subterfuge.
In addition, the increasing constraints on political freedom are evidence of how the constitutionally safeguarded practice of fiscal federalism is being affected.
The Narendra Modi government has weaponised fiscal devolution for meeting political ends, especially in its conflict with the non-BJP state governments like West Bengal, Kerala, Karnataka, Tamil Nadu, to name a few.
There’s another concern: the issue of goods and services tax, or GST.
In terms of magnitude of GST revenues, states have done well since the idea of a “single unified market” via the introduction of the GST came about in 2017. However, this increased volume of revenue, anchored by temporal reasons of increased revenue-share, came at a huge price in terms of the true spirit of democratic federalism.
In any voting exercise within the GST Council, the Centre carries a weight of one-third (33.33%), with the balance two-thirds (66.67%) shared by the states.
So, for a proposal to be approved, it needs the support of 75% of the total voting weight.
The BJP is now in power in 12 of the 28 states in India and is in the ruling coalition in four others. And in December 2019, it had shifted to voting from its tradition of taking consensus-based decisions to settle all matters.
The state governments have also lost their ability to independently collect revenue from the sales tax. Additionally, there’s a trend towards centralisation of power in politics, which could reduce states’ ability to find new revenue sources or borrow money for their expenses in the future.
Each of these issues merit wider attention, especially in the context of the upcoming general election.
From the aggrieved states’ perspective, there are three key principles that can ensure a better partnership based on trust and a more robust federal-finance relationship between the Centre and states.
Also read: Amid India’s Silent Fiscal Crisis and Fragile Federalism, 16th Finance Commission Has an Uphill Task
Vertical equity
The principle of vertical equity in public finance entrusts a government to ask those who earn more or have a higher wealth to pay more in their share of contributed revenue.
India has a complex system of intergovernmental fiscal relations. This complexity has its roots in a number of factors, including ethnic, social, and economic disparities among states/regions, as well as the long-standing vertical-imbalance between the expenditure and revenue raising responsibilities of the state governments.
This imbalance in the past was covered by revenue-sharing arrangements, in which states, particularly developing states, received a variety of grants from the Centre. Even if grants are not allocated, the Centre can do more in reducing the cesses/surcharge composition in the macro-tax weightage, while imposing a larger share of direct tax burden on the top 10% of the wealth-asset endowed class, safeguarding a larger devolved proportion of that ‘tax’ revenue for states, that need additional resources.
This author had earlier discussed a proposal to levy a ‘consumption tax’ on the richer (top 10%) asset class, consuming a larger proportion of luxury goods, that can help them pay more as compared to other classes who pay a similar amount of tax (in case of GST or other indirectly imposed tax) irrespective of the income they earn or the wealth they endow.
Proportionality
Proportionality, in a jurisprudence sense of public law and political theory, appeals to ‘reason’ and ‘reasonable’ conduct for the way a court sentences a convict, or how a parliamentary body or executive may choose to function.
One cannot (or shouldn’t) use a cannon to fire a sparrow. Balancing means with ends matters. The Finance Commission has a mandate in recommending ways for the central government to be more reasonable and proportionate in the way they organise their devolution framework with the states in a time-sensitive and needs-based manner.
At a time when the federal faith and mutual trust in the Centre-state relations have taken a more ‘uncooperative’ turn, largely due to political factors, it would be interesting to see how the new 16th Finance Commission handles this growing friction back to its original charter: of ensuring ‘pooled sovereignty’ in the truest sense.
Juridical precedence
The idea of pooled sovereignty, seen as foundational to the functioning of the GST, has come under threat due to a Supreme Court judgment, Union of India vs. Mohit Minerals, in which a three-judge bench, presided by now Chief Justice D.Y. Chandrachud, explained by Gautam Bhatia recently, held that the GST Council’s decisions are not binding on legislative bodies and that both Parliament and state legislatures possess plenary powers to make laws as they deem fit.
In examining the case that came to the Supreme Court, the bench considered the purport of Article 279A and made a series of findings, explained by Bhatia, which could “potentially dismantle the idea of GST as understood through the 101st amendment” (via which the legal way for creating a GST was made possible).
The court recognised that the GST Council’s “recommendations” cannot be observed as binding (on states) since it would violate the supremacy of Parliament and the state-legislatures since both have been afforded “simultaneous” legislative power on GST. Secondly, the virtual veto given to the Union in the GST Council would lead to a violation of fiscal federalism.
In addition to the two federal principles discussed, the court in this case has provided a strong juridical precedence for states to exercise their parliamentary power and not see the GST Council’s recommendations as binding, when the Centre refuses to act in a ‘reasonable’, ‘proportionate’ manner, in its own devolution practice for either political or any other reasons.
The 16th Finance Commission must address and resolve critical issues such as the sharing of resources from the divisible pool and the extent of cesses and surcharges. There are historical wrongs in vertical devolution that merit greater attention.
At the same time, in the absence of a political will to engage with principles, due process, and constitutional morals, as evident in the fiscal conduct of the Centre – which has put political means over anything else in its relationship with states and other institutions – how and to what extent the Finance Commission addresses these issues with an ‘independent, non-partisan mandate’ will remain a question to be answered on its own.
Deepanshu Mohan is Professor of Economics, Dean, the Office of Interdisciplinarity and Director, Centre for New Economics Studies (CNES) at O.P. Jindal Global University. He is a Visiting Professor at the London School of Economics and Political Science and has Visiting positions at University of London, University of Ottawa, Stellenbosch University (to name a few).
