The report of the committee for a composite development index (CDI) for states, released in late September, has attracted criticism for having been politically motivated to give a larger share to Bihar in fiscal flows from the Centre. Of greater interest than the motivation is how the committee addressed its task, and what its collective effort led it to.
The report has two aspects. In the first and most harmless, it is an exercise along the lines of the human development index (HDI), using an assortment of outcome indicators to quantify and rank states on a scale. Indeed, the report plots a scatter of its CDI against the HDI and finds a very high negative correlation of 0.9. Negative, because the HDI assigns high scores to high achievers, like any academic test. The CDI, on the other hand, assigns high scores to low achievers. That gets us to the second (and main) task of the report, which is to quantify the relative entitlement of states in development funding from the Centre, grounded in their low achievement.
This aspect of the report is more problematic. Even the dissenting member agrees with the committee's use of outcome variables for the ranking, rather than what they call background or process variables. He merely disagrees with inclusion of per cent scheduled caste/scheduled tribe population, because it is not an outcome variable, and with the use of per capita consumption rather than income.
Outcome variables have in the past been used in Plan schemes floated by the Centre, such as the Sarva Shiksha Abhiyan, whose objective was to even out the primary education deficit in deprived regions. Or the Pradhan Mantri Gram Sadak Yojana, which provides last-mile connectivity for villages not so linked, thereby favouring states with a large number of marooned villages. There can be no legal challenge to such schemes, because the Centre is autonomous within the federation and therefore free to address particular outcome deficits across the country.
But when a whole bunch of these deficits are pooled together as a basis for determining overall state shares in development funding, that becomes an approach subject to legal challenge. Why does pooling become a problem, when funding a specific outcome deficit is not? Simply because this then becomes an unconditional fund flow, and thus mimics the statutory tax share prescribed by Finance Commissions, which similarly quantify unconditional relative state entitlements. When that happens, the formula must necessarily begin from a neutral construction of the relative needs of states. What the Constitution most certainly permits is adjustment of this neutrally obtained entitlement for the relative fiscal capacity of states to meet these needs themselves. Any measure of relative prosperity like per capita income comes in here not as a measure of poor outcomes, and hence higher entitlement, but as a measure of fiscal self-sufficiency (or lack thereof).
Per capita income is not the best indicator of fiscal capacity. I have written on how better measures of fiscal capacity are possible, and on the poor quality of the per capita income figures used. Once the goods and services tax (GST) comes into being, we will have a readily available measure of relative tax capacity in place, and could then perhaps approach the Canadian ideal in respect of adjusting for fiscal capacity. The point here is that a poor state's claim to higher shares in central flows can only rest on its low fiscal capability to meet its needs itself. But the basic building blocks of need have to be neutral across states. The report acknowledges the perverse incentive properties of the CDI, and prescribes a one-quarter share in the final formula for improvements in performance (ie reductions in the CDI). But the CDI clearly overrides the performance component.
The very "background" variables that the committee rejects for arriving at relative entitlement are in fact the only bases acceptable to states. They have also accepted adjustment for the cost disability posed by hilly terrain, although placing 11 states in a special category may have been a ham-handed way of dealing with it. I have written on how better measures of cost disability are possible ("Is Bihar a special category state?" Business Standard, April 24, 2012). The committee does use the basic cross-state neutral indicators of need, population and area, but merely as 80:20 weights to the CDI, which is constructed from outcome disparities on 10 indicators.
The requirement of neutrality, and the rejection of perverse outcome incentives, is taken so seriously in our country that the very terms of reference of Finance Commissions over the last 40 years have mandated the use of frozen population shares by the 1971 census, so as not to reward states that went easy on population control. This feature, just by itself, has reduced the share of Bihar relative to what it would have been with the use of current population. Only the current 14th Finance Commission has been given some leeway, by being allowed to consider "demographic changes subsequent to 1971".
The CDI gives Bihar a 12.04 per cent share, as against what the report says was a 10.06 per cent share across tax shares and grants awarded by the 13th Finance Commission. The 13th Finance Commission tax share, the more appropriate comparison, was 10.92 per cent. If the 13th Finance Commission share were reworked with current population, and with fiscal capacity more carefully assessed, it would easily cross 11 per cent.
The excess of the CDI over this revised tax share yields a rough and ready measure of the (accumulated) governance deficit in Bihar. The people of Bihar undeniably suffer from acute outcome deficits, which call for urgent redressal, in mission mode. Foremost among these must surely be the eradication of Japanese encephalitis, an annual visitor at this time of year, which leaves dead and disabled children in its wake in several districts of Bihar and Uttar Pradesh. Targeted interventions with measurable outcomes are a better way by which to confront these horrific consequences of accumulated governance deficits, rather than more unconditional funding poured into those deficits.
The writer is a retired professor of economics
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