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The 14th Finance Commission (FFC) submitted its report by early 2015. It has advised for far-reaching changes for sharing of revenues between the Center and the States, on the one hand, and between the States, on the other. The advices apply on the period 2015–20 and are likely to have major implications for Center-State relations, for budgeting by, and the fiscal situation of, the Center and the states. ‘Successful implementation of the advices will advance the cause of cooperative federalism that the new government has enthusiastically embraced’, the Economic Survey 2014–15 concluded. Some of the major recommendations are as follows:
(i) It has radically enhanced the share of the states in the central ‘divisible pool’ of taxes from the current 32 per cent to 42 per cent which is the biggest ever increase in vertical tax devolution. The last two Finance Commissions, viz., Twelfth (2005–10) and Thirteenth (2010–15) had recommended a state share of 30.5 per cent (increase of 1 per cent) and 32 per cent (increase of 1.5 per cent), respectively in the central divisible pool.
(ii) It has also proposed a new horizontal formula for the distribution of the divisible pool among the states. There are changes both in the variables included/excluded as well as the weights assigned to them. Relative to the Thirteenth Finance Commission, the FFC has incorporated two new variables—
(a) 2011 population and forest cover; and
(b) Excluded the variable relating to fiscal discipline.
(iii) Implementing these recommendations will move the country toward greater fiscal federalism, conferring more fiscal autonomy on the states. For example, based on assumptions about nominal GDP growth and tax buoyancy and the policy measures that are contemplated for 2015–16, it is estimated that the additional revenue for the states could be as much as Rs. 2 lakh crores relative to 2014–15. Of this, a substantial portion represents the difference that is purely due to the change in the States’ share in the divisible pool.
(iv) Preliminary estimates suggest that all States stand to gain from FFC transfers in absolute terms. However, to assess the distributional effects, the increases should be scaled by population, Net State Domestic Product (NSDP) at current market price, or by States’ own tax revenue receipts. This will make the following effects on the ststes’ revenue—
(a) The biggest gainers when scaled by any of these indicators tend to be the Special Category States (SCS, mostly those in the North-East) and by orders of magnitude.
(b) The major gainers in per capita terms turn out to be Arunachal Pradesh, Mizoram and Sikkim for the SCS states and Kerala, Chhattisgarh and Madhya Pradesh for other states (GCS or General Category States). Clearly, this increase in taxes to the States is sustainable for the center, only if there is a reduction in the central (Plan) assistance to the states (CAS).
In other words, States will now have greater autonomy both on the revenue and expenditure fronts.
(v) It is also possible to tentatively estimate what the FFC recommendations would do to net spending capacity of the States, where net refers to the difference between the extra FFC transfers and the reduced CAS that will be required by the FFC recommendations. Broadly, the Special Category States will be the biggest gainers. In addition, there are nine States among the GCS which are expected to get more than 25 per cent of their own tax revenue.
(vi) A collateral benefit of moving from CAS to FFC transfers is that overall progressivity will improve; that is, on average, States with lower per capita NSDP will receive more than those with a higher per capita
NSDP. This results from the fact that CAS transfers, which tended to be discretionary, were less progressive than Finance Commission transfers.
To be sure, there will be transitional costs entailed by the reduction in CAS transfers. But the scope for dislocation has been minimised because the extra FFC resources will flow broadly to the states that have the largest CAS- financed schemes.
The far-reaching recommendations of the FFC, along with the creation of the NITI Aayog, will further the government’s vision of cooperative and competitive federalism. The necessary, indeed vital, encompassing of cities and other local bodies within the embrace of cooperative and competitive federalism is the next policy challenge, which is believed to be strengthened by the body NITI Aayog.