Evolving Centre–State Financial Relations

After the Fourteenth Finance Commission award, aggregate transfers as a percentage of gross domestic product has increased, while grants as a percentage of GDP has declined. The centre is resorting to cess and surcharges that are not shared with the states. This would mean denial of revenue to states, which goes against the spirit of the Constitution. Further, the states have a reduced untied fi scal space, with the union’s share in Centrally Sponsored Schemes in 2016–17 (BE) being reduced. Finally, in the absence of plan transfers, post 2017–18, the focus should be to develop a framework for non-fi nance commission grants to states which is predictable and certain.

Budget 2016–17 has made three important observations relating to central transfers to states. The first relates to the quantum jump in the devolution of taxes post the Fourteenth Finance Commission (FFC) award and resultant fiscal autonomy to states. The second relates to restructuring of grants based on the revised funding pattern proposed by the Sub-group of Chief Ministers on the rationalisation of Centrally Sponsored Schemes (CSS). The third relates to effective outcome-based monitoring of implementation of schemes and doing away with the plan and non-plan expenditure distinction in the budget after the completion of the Twelfth Five Year Plan. This article analyses the likely implications of some of these proposals on the transfer of resources to states and on centre–state financial relations especially in the context of what we call the new framework for grants (NFG).

A brief overview of the changes in the system of transfer post the FFC award is critical to understand recent changes in centre–state transfers. The FFC recommended an increase in tax devolution to 42% of the divisible pool of taxes from 32% recommended by the Thirteenth Finance Commission (THFC). In order to accommodate this large increase in tax devolution, the union government in Budget 2015–16 restructured the flow of grants to states. This restructuring had three components: (i) for a set of schemes central support was withdrawn, (ii) for another set of schemes the union government changed the funding pattern, and (iii) for some schemes it continued with the existing arrangement of grants.¹ The process of restructuring continued during 2015–16 and a subgroup of chief ministers was set up by the NITI Aayog to examine the rationalisation of CSS. Based on the recommendations of this subgroup, grants were further rationalised. The NFG is incorporated in Budget 2016–17. We examine the implications of enhanced tax devolution and NFG on the transfers to states and on the evolving centre–state financial relations.