Terms of reference row: Finance panel unleashes states' ire before award

There will always be some states disgruntled over the devolution formulae of finance commissions (FCs).

However, probably for the first time, the terms of reference (ToRs) of an FC have stirred a controversy. To the extent that finance ministers of most southern states came together to register a protest. And, plan to broaden their group by including other states, including Punjab and West Bengal. 

The positive side of such a development is that the protest will not remain only a divide between  northern and southern states. However, it is taking a political shape, of a battle between the Bharatiya Janata Party (BJP) and its allies versus opposition parties.    

It is primarily shifting of the census base from 1971 to 2011 that has triggered apprehension among these states. that they would not be fairly dealt with by the 15th Finance Commission (FFC), headed by former expenditure secretary N K Singh, for devolution of funds. Southern states allege a shift from the 1971 census will work against states which have worked towards population control – the south is well ahead of the north in this.

The issue has since gone beyond population. Other ToRs, including the ones on populism, revenue deficit grant, review of the 42 per cent tax devolution to states and conditions that could be attached to the transfers, are drawing flak. 

Other objections

In what could rankle some states further, Business Standard has learnt from informed sources that the FFC could come up with a definition of ‘populist schemes’.

Among the ToRs provided to the FFC, it has been mandated with considering measurable performance-based incentives for states. The parameters on which these could be measured include how well they implement flagship schemes of the central government and control expenditure on populist measures.

“If the FFC does include this in its deliberations, it will define what a ‘populist measure’ means, what programmes and announcements by state governments can be considered populist and what are not,” said a senior central government official.

“This is problematic on many levels. The Centre is no one to decide how states should spend their money. No central-appointed body gets to lay down what constitutes a populist scheme,” said a senior independent economist. The person works on government-appointed panels and, hence, did not wish to be named.

Abhijit Sen, member of the previous FC, wondered if  loan waivers would be considered a populist scheme,  or power or transport subsidies. If so, people will charge the FFC with dancing to the tune of the Centre’s dictates, he said.

Govinda Rao, a member of the same 14th FC, posed a query — is recapitalisation of public sector banks to the tune of Rs 800 billion, a present priority of the Centre, not a populist scheme? “The government is providing taxpayers’ money for the mess they have created themselves,” he said.   

“States have the right to focus on their own schemes, which are similar to flagship central schemes. They cannot be penalised or not rewarded for focusing on their own schemes,” the economist said.

Central officials differ on this contention. A second official said central money is allocated to states on the basis of central schemes, with specific targets. “If you are not spending the money for the scheme it is earmarked for, you will not be allocated further sums,” the official said.

A number of experts, including the economist quoted above, and a member of the FFC, say in the run-up to the 2019 general election, the ToRs and working of the FFC will become increasingly politicised. “We have to submit our report after the 2019 election but our work till then will lead to political flashpoints. The FFC cannot make any amendments to the ToRs, as these are given to us by the President of India under the Constitution. We will listen to all the concerns that any state might have,” an FFC member said.

Then, there is a controversial ToR which mandates the FFC to assess whether revenue deficit grants to states are needed. Rao said this ToR is contrary to the Constitution, since Article 275 of the latter provides for such grants.

The 14th FC gave these grants to 11 states, feeling the devolution it recommended might not suffice to cover their revenue gaps. During the 2015-20 period, these grants are estimated to be around Rs 1.95 trillion. One of the ToRs also asks the Commission to look at the impact on the fiscal situation of the Union government of the substantially enhanced tax devolution to states, following the recommendation of the 14th FC. Which had recommended increasing the share of devolution of the divisible tax pool to 42 per cent, from the earlier 32 per cent.

Sen said the Commission on its own could look at the recommendations of its predecessor and make it less or more. If the Centre wanted, it could have given this in its memorandum to the Commission and not in the ToRs.

Too wide?

Then, there is the issue of too many and unnecessary ToRs this time. The Commission has been asked to look at efforts made by states in expansion and deepening of the tax net under GST, promoting of a digital economy and ease of doing business. Sen says too many ToRs make the functioning of a Commission tougher. The latter’s job is to suggest devolution of funds, not to promote a digital economy, he argued.

It was the 13th FC, under Vijay Kelkar, which imposed many conditionalities on these grants. One could also argue that the 12th FC, under C Rangarajan, also recommended improvement in fiscal parameters as the condition for continuation of central loans to states. But, then, the FC is supposed to look at the fiscal deficit positions of states and Centre. This is its job but not to promote ease of doing business in states, said one economist. 

Census issue

On population, the official version is that the shifting of base should be read with another ToR, on replacement rate. This would be considered by the FFC and go in favour of the states which are now up in arms. Replacement rate is the fertility rate, required to maintain the current population, and the southern states are well ahead of the north on this.

Sen said at least 10 states would lose because of a shift in population base from the 1971 to 2011 census. All southern states, barring Telangana, will lose, he said. That might explain why Telangana was not there in the southern state FMs' meeting against the ToRs earlier this week.

Big losers would include West Bengal and Odisha; possibly also Punjab and Assam.  

Among these 10 states, save for Assam, all others are non-BJP-ruled. So, a wrong message has gone out, he said.

The opposing states are trying to get Assam to join them, for the same reason. 

The finance ministers of Kerala, Karnataka, Andhra Pradesh and Puducherry met in Thiruvananthapuram  on Tuesday and came out against the ToRs. There has been a prolonged political fight over the FFC’s mandate to use the 2011 census. 

Kerala Finance Minister Thomas Isaac said at the meeting that Tamil Nadu, Telangana and other non-BJP states like West Bengal, Odisha and Punjab will be invited to another conference of southern states in Visakhapatnam next month. 

Senior finance ministry officials told Business Standard that the southern states have written separately to seek a change in the ToRs, and specifically asked for going back to the 1971 census. However, central officials say the ToRs will not be amended.

The 14th FC gave a weight of 10 per cent to the 2011 census but their ToRs did not mention it. It only said the Commission should look into demographic changes since 1971 but the census base was 1971.

Finance Minister Arun Jaitley responded on the same day the FMs of southern states met. He said the ‘controversy’ around the ToRs was ‘needless’. And, that there was no inherent bias or mandate in the terms which could be construed as discriminatory against states that have made good progress in population control.

He underlined the inclusion of another reference, i.e 'efforts and progress made in moving towards the replacement rate of population growth’. “This ToR recognises the efforts of all the states which have done well in population control,” he said.

Sen says this ToR is a secondary thing. He said the issue is one of principle, as the 1971 census is not only used in devolution of funds but also delimitation of parliamentary constituencies. There was agreement between the Centre and states at the time that the 1971 census will be used, to ensure the states controlling their population will not be disincentivised.