Squeezing the states

This year happens to be one such five-year interregnum, with the 12th Finance Commission giving an extra percentage point of central revenue to the states, raising the figure from 29.5 per cent to 30.5 per cent (the benefit is about Rs 3,000 crore). Over and above this, the Commission has made life easier for the states by asking that central transfers be in the form of grants rather than loans.

The Centre has been generous on its own: it has gone in for debt swaps that allow states to repay old, high-interest loans to the Centre and take cheaper loans from the market.

Also, the Centre has been passing on small savings and other forms of capital to the states directly, without being an intermediary or making any charges for intermediation services (as used to be the case).

And this year, the Centre has gone to the extent of underwriting state VAT revenues, and provided Rs 5,000 crore for this in the Budget. It would seem from all this that the Centre has been very helpful to state governments""most of which are in desperate financial straits.

While the individual elements of that story are unquestionable, the overall picture can be drawn differently. It could be argued, for instance, that in increasing the role played by surcharges and cesses in central taxation, the Centre is squeezing the states""because these imposts do not have to be shared under the Finance Commission's 30.5 per cent formula.

In moving from a 35 per cent corporation tax rate to a 30 per cent rate, plus a 10 per cent surcharge (plus last year's 2 per cent education cess), the states now get less than 90 per cent of the tax taken from companies.

That could mean a loss of about Rs 10,000 crore, since the corporation tax revenue next year is expected to be Rs 110,573 crore. It does look like the Centre has tried to neutralise the Finance Commission's giveaways, said to total Rs 26,000 crore next year.

Long-term trends also suggest a lack of generosity. For instance, aid to states as a component of government expenditure has fallen steadily, from 25.1 per cent in 1991-92 to no more than 16.8 per cent in 2003-04.

In relation to GDP, the Reserve Bank's figures suggest a shrinking of central transfers to the extent of more than 1 per cent. This means that squeezing the states accounts for the bulk of the fiscal "correction" that has taken place at the Centre.

From the states' point of view, this squeeze accounts for about half of their fiscal deterioration, since the states' gross fiscal deficit rose from an annual average 2.8 per cent of GDP in the 1990-95 quinquennium to 5.1 per cent of GDP in 2003-04.

There is also an optical illusion element to the reduction in the central deficit in the last two years.

For, while the debt swaps in this period have helped states reduce their interest burden, they have made it possible for the Centre to show a sharp drop in its deficit (because the states have repaid loans) while what is not seen in these numbers is the fact that the states have borrowed an equivalent amount from the market.

In other words, the total deficit of the government system (Centre and states combined) has not shrunk. Correct for all this, and on a like-to-like basis, there has probably been no fiscal correction at the Centre since Manmohan Singh's first Budget of 1991-92.