The 15th Finance Commission tries not to rock devolution boat given GST’s ongoing troubles

The interim report of the 15th Finance Commission, tabled in Parliament on Saturday, has largely preserved the devolution mathematics of its predecessor, belying concerns of a sizeable cut in States share. The commission has recommended a one percentage point reduction in the vertical split of the divisible pool of tax revenues accruing to States to 41%. This follows the reorganisation of the erstwhile State of Jammu and Kashmir into the Union Territories of Jammu and Kashmir and Ladakh. While the former States notional share based on the parameters for horizontal devolution would have been about 0.85%, the commission has cited the security and other special needs of the two territories to enhance their aggregate share to 1%, which would be met by the Centre. As part of an effort to balance the principles of fiscal needs, equity and performance as well as the need to ensure stability and predictability in transfers, the criteria for the horizontal sharing of taxes among States have been rejigged. A crucial new parameter, demographic performance, has been added to the mix. Having been mandated to adopt the population data from the 2011 Census, the commission has incorporated the additional criterion to ensure that States that have done well on demographic management are not unfairly disadvantaged. And since the norm also indirectly evaluates performance on the human capital outcomes of education and health, it has been assigned a weight of 12.5%. This should address the concerns voiced by several States over the switch to the 2011 Census from the 1971 data.
Among the States, with the exception of Tamil Nadu, all the other four southern States see a reduction in the recommended share of taxes for the year 2020-21. Notably, the suggested devolution to Odisha and Uttar Pradesh have also shrunk in percentage terms. Crucially, the commission has flagged the issues dogging the GST, especially as indirect taxes constitute almost half the total tax revenues of the Union. From the sizeable shortfalls and volatility in collections, to serious cases of fraud, the new tax has yet to stabilise leaving a majority of the States dependent on compensation from the Centre. The commissions effort to improve the granularity in devolution to local bodies has generated some interesting results. Urban local bodies, especially municipalities in cities with populations of more than one million, are set to get a larger share of the pie. However, the increase in the percentage of outcome-tied funds to 50%, from 10%, could prove vexing to the last mile providers of basic services in Indias federal and highly fragmented structure of governance. The commission has also been justifiably critical of the Union and State governments tendency to finance spending through off-budget borrowings and via parastatals. It has done well to ask that such extra-budgetary liabilities be clearly earmarked and eliminated in a time-bound manner.