Euphoric states may gain little from new tax devolution plan

Centre unlikely to be squeezed fiscally as transfers recommended for 2015-16 are only 87 basis points higher than 2014-15 Budget estimate

On the face of it, the recommendation of the 14th Finance Commission to increase tax devolution to states to 42 per cent may seem to be severely constraining the Centre's fiscal space. But a closer look at the numbers suggests that total transfers from the Centre to the states in previous years have been in the same range.

The tax devolution to states and the grants together account for 47.72 per cent of the divisible pool for the 2015-20 period. Add to this the provision for other transfers to states estimated by the commission at 15.72 per cent, and this works out to 63.44 per cent. This is less than two percentage points higher than the 2014-15 Budget estimate.

For 2015-16, the transfer by the central government to the states would be only 87 basis points higher at 62.75 per cent as compared to 61.88 per cent in 2014-15. The additional burden may, however, be offset to some extent by the fall in crude oil prices. The price fall could reduce the subsidy burden of the government in 2015-16 by roughly half of Rs 63,500 crore, the amount budgeted for the subsidy in the current fiscal year. This would greatly ease the government's fiscal space.

In fact, the average of the actual Union transfers to states from 2010-11 to 2013-14 and Budget estimates of 2014-15 would be higher than 65 per cent. The 13th Finance Commission had recommended raising the indicative ceiling to 39.5 per cent. But trends show that actual transfers to the states from the divisible pool were of a much higher magnitude. According to data presented in the report of the 14th Finance Commission, total transfers to the states as a percentage of the divisible pool exceeded 60 per cent in the five-year period of the previous commission.

The trend is visible in not just the previous five years but also in the period of the 12th Finance Commission. Revenue transfers had exceeded the indicative ceiling of 38 per cent of gross revenues of the Union government set by the commission. The 14th Finance Commission acknowledges this, stating that, "The indicative ceiling prescribed by the previous finance commissions, therefore, has not restrained the Union government from making larger transfers to the states under centrally sponsored schemes (CSS)".

A higher or lower percentage of transfers may not necessarily correspond to higher or lower transfers in absolute numbers. Robust revenue collections could lead to higher absolute transfers even when the percentage of devolution is lower.

Every year, transfers by the central government to the states include a portion of the tax revenue, grants in line with the recommendations of the Finance Commission, grants for Plan purposes given by the Planning Commission and grants for CSS designed by central government ministries. In addition to these transfers, the central government also makes direct transfers to state-level implementing agencies.

While accepting the recommendations of the 14th Finance Commission, the Union government had noted that higher devolution would have an impact on the Centre's fiscal space.

"The consequence of this much greater devolution to the states is that the fiscal space for the Centre would be reduced in the same proportion," stated a release by the finance ministry. But, according to figures stated in the commission's report, the total transfer to the states in the period ending 2019-20 would be less than 2 per cent higher as compared to the Budget estimates for 2014-15.

Though the tax devolution has increased, essentially increasing the untied grants to states, the commission has reduced provisions for other transfers as a lot of the transfers that were accounted for separately by the previous commission have been subsumed in the increased tax devolution.

A commission member explains that the recommendation has subsumed the central assistance given by the Planning Comm-ission, other central assistance for Plan, special Plan assistance, special central assistance and grants for items such as the backward region grant fund.