15th Finance Commission may need to work like it's the first: Subramanian

CEA suggests four separate 'pots' for tax sharing

Chief Economic Advisor Arvind Subramanian on Friday stressed the importance of the 15th Finance Commission in dealing with Centre-state issues even as India comes to terms with the common market formed through the goods and services tax (GST), as a result of which taxation powers have shifted more in favour of the Centre.

He suggested there was much to learn from the lessons of economic integration in Europe while dealing with India’s unique concerns.

He was speaking at a lecture organised by Business Standard in Mumbai. Such economic integration typically brings prosperity but also carries the risk of shocks transmitted from one state to another. States require the monetary means to deal with domestic problems. At the same time, there would also be issues that affect the country, which in turn requires the Centre to have certain powers.

“If you have a financial crisis which affects the country as a whole, the Centre should have the levers to raise resources,” he said. 

The 15th Finance Commission, under Chairman N K Singh, has the opportunity to redo fiscal arrangements between the states and the Centre, and put in place a framework for cooperative federalism that would help solve the country’s economic challenges (including such issues), he said. 

Subramanian suggested that tax sharing should have four “pots”. The first could consist of a default pot where states get back money based on their own tax base. The second would be a pot for redistribution among states in accordance with each state’s requirements. The third could be for risk-sharing. This would help to handle countrywide crises or even state-specific issues such as monsoons or drought.  The fourth and final pot would deal with the “low-equilibrium” trap at lower levels of government. 

The issue had also been dealt with in the Economic Survey of 2017-18, which is also a document authored by Subramanian. Local bodies such as panchayats collect very few taxes, but depend on grants from higher bodies such as the state or the Centre. There is poor service delivery, which, in turn, leads to weak tax revenue generation and weak accountability, and resource dependence leads again to poor delivery.

Some of this also reflects the inability or unwillingness to impose taxes on certain segments such as agriculture or property owing to the local government’s proximity to the local population. This may mean that certain taxes of this nature would perhaps be best dealt with at central level, said Subramanian. 

“I think land has to become a part of the (central) tax base,” he said.

He also made observations about redistribution. All the large contributors are not in the south, contrary to popular perception. They are in the west, south as well as the north, he said. He added that the Vindhyas were not the literal or metaphoric line between those who contribute a large deal and those who are largely recipients.

However, the contribution of southern states has been rising. The benefits to the Northeast have been declining. States such as Uttar Pradesh, Bihar and Madhya Pradesh have got an increasing share in successive Finance Commissions.

He suggested that levels of redistribution had perhaps begun to reach uncomfortable levels, which is why the issue of population-linked devolution had become a point of discussion, especially among contributing states. A move to use the 2011 population numbers instead of the earlier 1971 numbers met with protests after some states, especially the southern ones, held out this would adversely affect their share of tax revenues. This is not unique to a certain geographic section of the country.

“It is not a north-south divide,” he said. 

Trends on redistribution may change. The tax base of smaller and poorer states has increased in the first nine months of implementation of the GST. They would need less in the form of transfers.

But there are other problems to be solved. 

The absence of the Planning Commission would mean there is need for an institution to manage the four pots and deal with other related issues. The GST Council could play this role, according to him, and could help elaborate the Finance Commission recommendations and implement them.