ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Fiscal Transfers : Wrong Link

Wrong Link A correspondent writes: The states which have taken objection to the award of the Eleventh Finance Commission (EFC) have demanded, among other things, the rejection of the cap on total fiscal transfer to states of 37.5 per cent of gross central revenues recommended by the EFC and, going by the central government

The states which have taken objection to the award of the Eleventh Finance Commission (EFC) have demanded, among other things, the rejection of the cap on total fiscal transfer to states of 37.5 per cent of gross central revenues recommended by the EFC and, going by the central government's Action Taken Report (ATR), accepted by the centre. Whether or not the notion of capping total fiscal transfers is within the basic framework of federal financial arrangements laid down in the Constitution is a question that does not seem to have been raised by these states. Nor have the states demanded, jointly or individually, that the concept of capping, if it was not to work against the states, would have to be linked to the revenue effort of the centre. The EFC has failed to do this even while it has set targets for both the centre and the states in regard to their revenue performance. Thus while the commission acceded to the centre's plea for a "holistic approach" and "to take into account the fiscal transfer to the states from the central government in its entirety", it has overlooked the fact that between 1990-91 and 1994-95 the percentage of fiscal transfer had ranged from 38.72 to 44, or much above the proposed cap of 37.5 per cent. The commission has also ignored that without tying the recommended cap to the centre's revenue performance, the states would continue to face the prospect of never being quite certain of how much total fiscal devolution to budget for. At the same time, there will be no incentive for the centre to ensure that total fiscal devolution to states takes place at a steadily growing pace or at least to maintain it at the proportion it has already reached in relation to gross domestic product (GDP).

The point about maintaining the ratio of total central fiscal transfers to GDP remains even when calculating the share of the states in central tax revenues on the basis of the net proceeds of these taxes and not the gross proceeds, as recommended by the Tenth Finance Commission (TFC) under its alternative devolution scheme (ADS). Although even under ADS the share of the states was not linked to GDP, the fact that the TFC proposed sharing on the basis of gross and not net proceeds is significant in that it provides no incentive to the centre to keep the shareable proceeds low by netting gross proceeds to the maximum extent possible. Thus if surcharges are nettable, the centre would have an incentive hereafter to raise revenue through surcharges rather than basic taxes and duties. It is important that the EFC has chosen to depart from the original ADS by recommending sharing of central tax revenues on the basis of net and not gross proceeds. Of course, the excuse is provided by the 89th Constitution Amendment Bill which virtually rules out sharing by the states on the basis of the gross proceeds of central taxes. That did not, however, preclude the commission from setting a limit on netting and that could have been done best by linking the shareable net proceeds of central taxes to GDP.

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