Central Transfers: Arresting the Decline in Shares of Some States

Why in News?

• The Sixteenth Finance Commission faces numerous challenges, with an important issue raised by several southern states in India regarding the decline in their share of resources transferred from the Centre.
• The issue (or the complaint) is that these States have been facing a decline in their share out of the resources transferred from the Centre to the States, from Finance Commission to Finance Commission.
• Therefore, it becomes crucial to understand factors contributing to this decline, focusing on the income distance criterion, changes in population data, and the divisible pool.

Analysis of the Decline in Shares

• A Steady Decline in Share of Southern States
  • The Twelfth Finance Commission marked the beginning of a trend where southern states saw their share decline from 19.785% to 15.800% by the Fifteenth Finance Commission.
  • This steady decrease has raised concerns among state governments and policymakers about the fairness and equity of resource distribution, prompting a closer look at the criteria influencing these allocations.
• Decline in Share Due to Horizontal Distribution Criteria
  • A comparative analysis of the shares of different groups of states reveals a pattern where northern and eastern states, along with the southern states, have experienced a decline in their share.
  • On the other hand, hilly, central, and western states, including Maharashtra, have emerged as 'gainer '
  • This trend suggests that the horizontal distribution criteria have not favoured certain regions consistently, leading to a redistribution of resources among states.

Criteria of Share Distribution and Related Controversies

• The Distance Criterion: A Crucial Role in Resource Allocation
  • The role of the distance criterion in tax devolution is a pivotal aspect shaping the distribution of resources among states, as determined by Finance Commissions in India.
  • This criterion, assigned the highest weight in the allocation process, operates on the principle that the farther a state is from the highest income state, the higher its share in the resources transferred from the Centre.
  • The shares of individual States in tax devolution depend on the criteria and the weights used by different Commissions.
  • The distance criterion has been accorded the highest weight amongst these criteria.
  • Its weight was reduced from 50% to 47.5% by the Thirteenth Finance Commission and further reduced to 45% by the Fifteenth Finance Commission the Eleventh Finance Commission had given this criterion a weight of 62.5%. 
• Impact on Southern States Due to The Distance Criterion
  • The primary impact of the distance criterion is seen in the case of southern states in India, where a steady decline in their share of resources can be attributed to this specific parameter.
  • The mechanism implies that states with a greater income disparity from the highest income state face a higher allocation, while those with a smaller disparity experience a reduced share.
  • In the context of southern states, this has resulted in a notable decrease in their resource allocation from the Twelfth to the Fifteenth Finance Commission, raising concerns among state governments.
  • Between these two Finance Commissions, the loss to the southern States due to the distance criterion amounted to 8.055% points, although the overall loss was much less at 3.985% points, implying that there was a gain under other criteria.
  • Although on account of the distance criterion, low-income States such as Bihar and Uttar Pradesh have gained over time, they have lost on account of other criteria.
• Population Data and Demographic Criterion
  • One other criterion that has caused some controversy is population. Until the Fourteenth Finance Commission, the data for the population in 1971 was used. For the Fifteenth Finance Commission, data for the population in 2011 was used.
  • However, in order not to penalise States that showed better performance in reducing fertility rates, the demographic change criterion was introduced.
  • The joint impact of these two changes has been marginal for all groups of States and for Tamil Nadu, the joint impact was marginally positive.

Steps to Address Concerns and Controversies Related to Distribution Share

• Reducing the Weight of the Distance Criterion
  • One proposed step to address the concerns is to strategically reduce the weight assigned to the income distance criterion.
  • Currently set at 45%, a reduction by 5% to 10% points could help mitigate the disproportionate impact on states with closer income proximity to the highest income state.
  • This adjustment aims to strike a balance between recognising income disparities and preventing significant losses for states within specific geographical distances.
• Enhancing Weights of Other Criteria
  • To counterbalance the reduction in the weight of the distance criterion, the Sixteenth Finance Commission could consider enhancing the weights assigned to other criteria.
  • Criteria such as population, area, and demographic changes may warrant increased emphasis to ensure a more comprehensive and nuanced approach to resource allocation.
• Addressing Cesses and Surcharges
  • Another critical aspect to consider is the impact of cesses and surcharges on the divisible pool.
  • The Fourteenth Finance Commission recommended raising the share of all states to 42%, but subsequent increases in cesses and surcharges have diminished the size of the divisible pool.
  • Setting an upper limit, perhaps restricting cesses, and surcharges to 10% of the Centre's gross tax revenues, could prevent further reductions in the size of the pool and safeguard the interests of the states.
• Reevaluating the Divisible Pool Size
  • The overall quantum of the divisible pool plays a pivotal role in determining states' shares.
  • While the Fourteenth Finance Commission's recommendation to raise the states' share to 42% was accepted, subsequent fluctuations in the divisible pool size due to changes in cesses and surcharges have impacted states' actual receipts.
  • A revaluation of the divisible pool size, considering economic trends and fiscal responsibilities, may be necessary to ensure states receive their allocated shares without undue reductions.
• Periodic Review Mechanism
  • Instituting a periodic review mechanism within Finance Commissions could enhance flexibility and responsiveness to changing economic dynamics.
  • A more frequent review, perhaps midway through the term, would allow for timely adjustments to criteria weights based on emerging trends and evolving state needs.
• Transparent Consultation Process
  • Ensuring a transparent and consultative process is essential for addressing concerns and garnering stakeholder feedback.
  • The Sixteenth Finance Commission could actively engage with state governments, experts, and other stakeholders during its deliberations.
  • It will create a collaborative approach to finding solutions and ensuring that the allocation process reflects the diverse needs and priorities of different states.

 Conclusion

• The concerns raised by southern states regarding their declining shares necessitate a nuanced approach by the Sixteenth Finance Commission.
• Balancing the importance of the income distance criterion with other criteria and addressing the size of the divisible pool through limiting cesses and surcharges are crucial steps towards ensuring fair resource distribution among states in India.

Q1) What is Fiscal Deficit?

Fiscal deficit refers to the difference between a government's total revenue and its total expenditure, excluding borrowing, during a fiscal year. It represents the amount of money the government needs to borrow to meet its expenses when its expenditures exceed its revenues.

Q2) Why is Fiscal Deficit Important?

Fiscal deficit is important because it reflects the financial health of a government. Persistent high deficits can lead to various economic problems such as inflation, high interest rates, and a burden on future generations due to increased debt servicing. Governments often aim to keep fiscal deficits in check to maintain economic stability and sustainability.

Source: The Hindu