Finance Commission recommends 42% devolution of divisible funds to states

Total transfers up from 39.5% to 47%

States will get a much higher share of central taxes, as the government on Tuesday accepted the 14th Finance Commission’s recommendation to devolve an unprecedented 42 per cent of the divisible pool to states during 20015-16 to 2019-20, against 32 per cent suggested by the previous commission.

This means in 2015-16, states will receive Rs 5.79 lakh crore of the Centre’s expected gross tax receipts of Rs 15.67 lakh crore. The share of states will rise 51.55 per cent compared to the 2014-15 estimate of Rs 3.82 lakh crore.

The Y V Reddy-headed commission recommended tax devolution form a larger part of the transfers from the Union government than earlier. It suggested the Centre devolve Rs 39.48 lakh crore of tax receipts during the five years starting next financial year. Considering the recommendation of Rs 5.37 lakh crore of grants to states, total devolution to states will increase to 47 per cent of the divisible pool in the next five years from 39.5 per cent suggested by the previous commission.
 

While the 14th Finance Commission said this would give adequate space to the Union government to keep its fiscal deficit at a recommended level of 3.6 per cent next financial year and, subsequently, to three per cent in each of the four following years, the Centre said this would reduce its fiscal elbow room. “The consequence of this much greater devolution to states is fiscal space for the Centre will reduce in the same proportion,” the finance ministry said in a statement.

To buttress its argument, the Finance Commission said during the five-year period, the government would have Rs 49.14 lakh crore left from the divisible pool.

“This (the recommendations) naturally leaves far less money with the central government. However, we have taken the recommendations of the 14th Finance Commission in a positive spirit, as they strengthen your hand in designing and implementing schemes according to your priorities and needs,” Prime Minister Narendra Modi wrote to chief ministers.

Finance Minister Arun Jaitley said previous Finance Commissions had recommended only one -two per cent increases in devolution. The commission’s suggestion on a fiscal road map would be examined separately in due course, the minister said in a statement.

OTHER KEY RECOMMENDATIONS

• Set up an independent council to undertake assessment of fiscal policy implications of Budget proposals
• Replace existing FRBM Act with a debt ceiling & fiscal responsibility law
• Wind up National Investment Fund and maintain all disinvestment receipts in the consolidated fund
• Amend electricity Act to provide for penalties for delay in payment of subsidies by state governments
• Submission of states on minimum guaranteed devolution turned down
• Steps for states to augment revenues, such as property tax reforms and issuance of municipal bonds suggested
• Set up autonomous and independent GST compensation fund

While suggesting grants to states, the Commission also did away with a distinction between Plan and non-Plan expenditure, a move that could have a bearing on the coming Budget.

The recommendations weren’t unanimous, coming with a dissent note from part-time member Abhijit Sen who said as the Centre’s net tax resources would shrink, implementing a shift to meet states’ demand for larger untied transfers would require a fairly drastic alteration than the present arrangements.

The commission wanted the Centre to de-link about 30 centrally-sponsored schemes from the support of the Union government. However, the finance ministry said only eight such schemes could be de-linked. “The details of changes in the sharing pattern will have to be worked out by the administrative ministry department on the basis of available resources from Union finances,” the ministry said.

The commission suggested performance-based grants to panchayats and local bodies. It was recommended the ratio of basic-to-performance grant be kept at 90:10 for panchayats and 80:20 for municipalities. It also suggested a grant of Rs 1.9 lakh crore to 11 states that would record revenue deficits if its recommendations were accepted. This would account for 36.25 per cent of the total grants to states for the five-year period.

Along with recommendations on the Centre’s fiscal deficit, the commission also sought states’ fiscal deficit be fixed at an annual limit of three per cent of gross state domestic product (GSDP), with flexibility of 0.25 per cent if its debt-GSDP ratio was up to 25 per cent in the preceding year.

However, it did not agree with the Centre’s position on effective revenue deficit and asked the government to do away with this from the next financial year.

As the earlier road map of having revenue balance by 2013-14 and surplus by 2014-15 seemed difficult, former finance minister Pranab Mukherjee had brought in the concept of effective revenue deficit (revenue deficit, excluding the capital expenditure incurred on various schemes) in 201-12 budget . The commission wanted the Centre’s debt outstanding to decline from 44.8 per cent of gross domestic product (GDP) in 2014-15 to 43.60 per cent next financial year and to 36.3 by 2019-20. It was recommended the total outstanding debt (along with that of states) be cut to 64.53 per cent in 2015-16 and to 58.24 per cent by 2019-20.