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Why the south-vs-north debate is a flawed way to analyse the 15th finance commission formula

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If this argument of south-vs-north is followed through, a direct corollary would be to also oppose money flows from Bengaluru to Bidar or from Whitefield to south Bengaluru.

The terms of reference for the 15th finance commission (FC) have come under attack from many quarters in the last few weeks. Of these, the most prominent line of attack is that using 2011 census data will end up hurting the interests of the southern states.

Since their population is one of the factors considered while distributing tax revenues among states, some say the southern states will be punished for controlling their population. To resolve this moral hazard, a few southern states are demanding that the dated 1971 census be used for the FC’s revenue distribution formula.

But this claim and the ‘north-vs-south’ debate sidestep other substantial flaws in the terms of reference for the 15th FC.

What are the FC transfers meant for?

The FC is responsible for recommending to the President the distribution of tax revenues between the Union and the states (vertical devolution), and between the states (horizontal sharing). The recommended distribution goes to the states in the form of un-tied transfers. This money does not come attached with a purpose; states can spend the money as they wish to.

The objective of such general-purpose transfers is to enable comparable levels of public services at comparable tax rates. Given that there is not a lot of difference in the tax rates of various states in India, this implies that per capita general purpose transfers from the Union need to go to areas where the levels of public services are poorer. This approach places an individual at the centre of policy-making regardless of the state where he or she resides.

Why the south-vs-north argument is a flawed one

If the objective of general-purpose transfers is to enable comparable levels of public services at comparable tax rates, it is only fair that the latest population data be used. Justifying the use of dated population data (1971 census) assumes that general-purpose transfers are levers for family planning. They aren’t. Family planning and population control are better managed through interventions on the expenditure side of budgets.

The idea of punishing individuals elsewhere in the country just because these areas continue to languish goes diametrically against the Indian Republic’s spirit. If this argument of southern-versus-northern states is followed through, a direct corollary would be to also oppose money flows from Bengaluru to Bidar, or from Whitefield to south Bengaluru.

What are the real arguments against 15th FC?

Specifically, two points in the terms of reference are in violation of the federal spirit enshrined in the Constitution. And these terms will result in an adverse impact on all state governments’ finances and limit their policy autonomy.

One, states could lose more than Rs 1.9 lakh crore in revenue deficit grants. By suggesting that revenue deficit grants may not be provided at all, the 15th FC is being nudged towards violating the provisions under Articles 275(1) and 280(3b) of the Constitution. As background, a total revenue deficit grant of Rs 1,94,821 crore was recommended by the 14th FC for 11 states. These grants are meant to correct vertical imbalances that stem from the constitutional assignment — while states account for 60 percent of public expenditure, they raise only 37 percent of the revenues.

Two, by suggesting that the impact of the “generous” devolution by the 14th FC be reviewed, the 15th FC is being nudged towards reducing the tax devolution to the states in order to meet requirements of the central schemes. But if general purpose transfers are reduced, all states will lose their policy independence and instead be limited to implementing central schemes. This goes against the spirit of federalism.

In any case, it is inaccurate for the Union to say that the 14th FC made an overly generous increase in devolution from 32 per cent to 42 per cent. As the 14th FC covered the requirements of both plan and non-plan expenditure, in reality, the increase was only from 39 per cent to 42 per cent. To imply that this increase of three per cent has limited the Union government’s fiscal space drastically highlights the fiscal profligacy of the Union government.

What states should do to protect their interests and their constitutional position

Given the direct negative implications of such terms of reference, state governments are right to register their concerns about the 15th FC. Going ahead, states should even consider legal recourse, as this is a constitutional matter. Political formations from all states across India must emphasise that tax devolution is a constitutional entitlement of the states and not a knob at the mercy of the Union government. Any attempt to reduce the tax devolution amount violates the federal spirit of the Constitution.

Finally, framing the issue in terms of a north-versus-south debate should not come in the way of highlighting these substantial issues, which are far more likely to hurt individuals in states all across India.

Pranay Kotasthane is a fellow at the Takshashila Institution. His Twitter handle is @pranaykotas

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1 COMMENT

  1. The author is can’t see the wood for the trees. The issue is not redistribution. The issue is mandating the use 2011 census data in the TOR of the finance commission without discussions, let alone consent. Moreover, there is no rationale provided for the departure from the existing norm, which was set for review in 2026.
    The move was arbitrary. Hence, the states are well within their rights to protest and even oppose such a unilateral move.
    Of course, most of the arguments by the politicians are for public consumption & are hence rhetorical in nature.

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