Finance commissions are set up every five years as a constitutional obligation to decide on the distribution of divisible pool of taxes by the Centre to the states. The 16th Finance Commission is at work now. Earlier, a major departure was made in the 15th Finance Commission wherein a state’s population count of 2011 replaced the conventional population count of 1971. Also, a fresh recognition of demographic performance of states was included among the list of criterion with differential weightage.
The two components of population count and demographic performance received a weightage of 15 percent and 12.5 percent respectively, which is a significant departure when compared with the weightage scheme adopted by earlier finance commissions. This undoubtedly generated a premature uproar among southern states. To be sure, 15th FC did adopt rationalization to account for population count on one hand and demographic performance on the other to strike a balance.
But has this balancing act led to any amount of rationalization in the ultimate share of devolution received by the states?
FC formula has upset some states
Based on the recommendation of the 15th FC, share of the states’ amount to 41 percent of the divisible pool, and its horizontal divide is in keeping with the six-point criterion of income distance, population count, area, forest and ecology, demographic performance and tax effort. While income distance is prominent among these with a weight of 45 percent, the next in order becomes demography that involves population count and demographic performance.
Here, there arises a concern as to whether a routine preference in resource allocation in the name of fairness and equity, which favour populous states, will strain the spirit of fiscal federalism.
A closer look at the trend of the share of receipt received by the states between the 10th to 15th FCs places three southern states, Karnataka, Kerala and Tamil Nadu, as consistent losers and Gujarat, Maharashtra and Rajasthan as systematic gainers.
The only exception among the populous states is Bihar which experienced a decline in its share and of late is maintaining the same at about 10 percent. Similarly, the most populous state of Uttar Pradesh too not only has the larger share of above 15 percent but maintained it for more than a decade.
These explicit divides in share of allocation among the states and consistent loss among the select states with better human development raises a contention as regards the sustainability of the attained feat and at the same time it also raises apprehension regarding fairness and equity of such an allocation.
Net contributions show gainers and losers cancel each other
A simple representative principle of equity is contested here with those who contribute more to receive less and vice versa. An analysis of the compositional share of central taxes in terms of the receipt they have per every rupee they contribute to the central pool of taxes among twenty major states offers a fair division of equal number of states as losers and gainers.
With losers receiving less than a rupee for every rupee they contribute, it appears that many states like Maharashtra, Karnataka, Haryana, Gujarat, Tamil Nadu and Telangana receive less than half of a rupee against a rupee they contribute. The worst off is Maharashtra which receives 8 paisa for every rupee it contributes amounting to a loss of 92 percent. Further, there are losing states of Kerala, Punjab and West Bengal receiving in the range of .57 to .87 of a rupee per every rupee they contribute.
Considering the scene of gaining states on this count, there is a moderate gain among the states with exception of Bihar that receives more than seven rupees against every rupee it contributes. This is absolutely unfair without any moderation on this count and how far and how long will this be sustainable, agreeable and tolerable remains to be seen. Finally, coming back to the share in the divisible pool, the declining share being quite distinct for Kerala and Karnataka, which has the potential to generate discontent that counters the spirit of federalism.
Solutions
The probable solutions to this apparent anomaly and unjust distribution is enlarging the share of the devolution amount from 41 percent of the divisible pool to at least 50 percent and a rational approach of incentivizing those who contribute while striking a balance between the states.
If at all control of resources by the union government cannot be reduced, there can be indirect means of financing through central schemes which can complement state endeavours in the domain of social security and welfare measures for aged, internal migrants and return migrants.
The current scene does not seem positive to qualify as fiscal federalism. This is at a time when we are on the verge of embracing another controversy of political representation with the period of freezing parliamentary seats based on 1971 population coming to an end in 2026. Such an environment calls for a greater dialogue and deliberation to address these concerns with a positive spirit to restore the federal character of our nation in this platinum era of our independence.
S Irudaya Rajan is Chair and U S Mishra Honorary Visiting Professor at the International Institute of Migration and Development (IIMAD)
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