Fiscal Federalism

Source: The Hitavada      Date: 27 Feb 2018 11:56:42

FOR fans of schadenfreude, Britain’s “brexit” shambles has provided much fodder over the last eighteen months or so. As the members of the campaign to leave the European Union are beginning to find out, the task of leaving an economic and political union is immense with unforeseen problems cropping up every other day. All the promised dreams of increased revenues and independence are evaporating in the face of the harsh realities of what promises to be a messy divorce.

The 15th commission’s proposal to use the 2011 Census figures as the basis to allocated union tax revenues will adversely affect the ability of many States to provide an effective welfare State for their residents. Southern States have (through a combination of improved health and education) reduced birth rates and total fertility rates far more than the northern States, and allocating union tax revenues on the basis of population will “punish” the southern States. Tamil Nadu has “lost” in terms of Union Tax revenue out of the divisible pool as a result of the 14th Finance Commission’s recommendations giving 10 per cent weightage to the 2011 population of a State in determining how much tax revenue a State will receive.
If 27.5per cent of weightage is given over to the population of States as of 2011, and if the same method is carried forward in future years, States which have lower TFRs will suffer in comparison to States which have higher TFRs insofar as allocation of Union Tax revenues is concerned.
A few things need to be clarified. Merely because the terms of reference of the commission require it to use 2011 census data does not mean that it cannot use any other census data or necessarily give it the weight. The 14th Finance Commission’s TOR also had a clause requiring it to use the 2011 Census data but after consultations and discussions with relevant stakeholders, the 2011 census data was given only 10 per cent weightage and the 1971 Census data 17.5 per cent weightage. There is no basis to assume that the weightage will be as high as 27.5 per cent or that they will not take other Census data
into account.

Furthermore, it is not as if the terms of reference are totally blind to the notion that a State improving the TFR should be encouraged – the commission is also mandated to come up with “measurable performance based incentives” in the progress made by a State towards replacement rate of population growth. Taking these into account, one would think that the concern that States which have managed to reduce their TFRs would be necessarily “punished” by the recommendations of the 15th Finance Commission is somewhat overblown. There are, however, other concerns with the FC’s TOR, specifically the importance it seems to give union schemes over State ones.
In understanding the implications of the report of the 15th Finance Commission, States have two broad sources of revenue – taxes levied and/or collected by them and share in union taxes under the Constitution. It is only a part of the latter that is divided in accordance with the 15th Finance Commission recommendations. States also receive discretionary grants from the union, usually in pursuance of its schemes. The FC’s recommendations also lay out principles on the basis of which such grants are made. Not all States are equally dependent on union tax revenues. On the basis of the latest data available, how much each State is dependent on union revenues, as a percentage of overall revenues of the State in the latest financial year for which data is available. The FC’s recommendations would therefore affect only the distribution of union revenues among the State and cannot affect how much revenue a State raises through its own taxes.

A caveat is necessary here: Even the available data may not be very relevant going ahead given that it is not yet known how the chips will fall once the GST regime becomes stable. Initial data suggests that it might favour well off States (like Tamil Nadu and Maharashtra) more than poorer States like Bihar given that consumption is also higher, being economically better off States. It is also necessary to re-iterate here that there is no legal or constitutional basis for claiming that merely because a State is the place at which union tax returns are filed, it should get exactly the same share of union taxes. Short of abolishing the union’s power to impose taxes entirely, this is not a feasible idea. To illustrate with an example, merely because Indigo, headquartered in Gurugram but offering its services across India, it is highly questionable if Haryana should automatically get the full share of the income taxes and Central GST paid by Indigo just because it happens to file its returns from there. Would it be possible to say that central taxes paid on Indigo’s flights between Mumbai and Bengaluru should automatically accrue to Haryana simply because Indigo’s headquarters are in that State? The positives of India being a political and economic union must not be dismissed so lightly. In the international context, the problems of taxation across jurisdiction are usually resolved through a double taxation avoidance agreement which divides taxing powers between signatory States.

States in India don’t need to enter into double taxation avoidance treaties, don’t need regional conventions to set common minimum standards for businesses, don’t require businesses to register subsidiaries in order to be able to do businesses nor are they required to individually negotiate for all these things with other countries. Labour can be hired across State boundaries without visas and permits, raw material transported easily without import barriers and goods exported likewise. All of these are constitutionally guaranteed as part of a “bargain” which also determines how union tax revenues are to be split between States, among other things. While there is political equality between the federating units of the Indian Union, a mechanism such as the Finance Commission is to ensure that there is some level of economic equality as well.
In this context, it makes eminent sense that the division of union revenues to the States is need-based -- which states need it more to ensure all round development.