The implications of the recommendations of the Fourteenth Finance Commission on finances of Bihar as a result of changes in the tied, untied and overall union devolution are identified. The data reveals that there is an increase in tax devolution, but its share in grants, plan and non-plan, has come down drastically, hardly reflecting any increase in the total resources transferred. In reality, there has been a decrease of 1.3 percentage points in the share of tax devolution for Bihar between Thirteenth and Fourteenth Finance Commissions. Along with the revenue loss due to liquor ban, this loss has huge financial implications for Bihar’s exchequer.

The authors are grateful to the referee for comments and suggestions and also thankful to Shaibal Gupta (director, Centre for Economic Policy and Public Finance, Asian Development Research Institute) for his continuous encouragement.

The recent debate induced by southern states on the Terms of Reference (ToR) of Fifteenth Finance Commission does not augur well for the sovereignty principle of federalism. The debate proves to be “South versus North,” but in reality, it is between the “developed and underdeveloped” states. These states have been rewarded for 50 years by the previous finance commissions for adhering to the population control norm. Now, as per the presidential order, the latest population (Census 2011) is included as one of the devolution criteria in the ToR of the Fifteenth Finance Commission. It should be noted that an increase in population of any backward state is not a wilful choice. Rather, this is the basic characteristics of a weak economy in most of the backward states. It is well known that the Fourteenth Finance Commission has already considered the 2011 population as demographic change. Even then, the developed states benefited the most by the award of the Fourteenth Finance Commission compared to the Thirteenth Finance Commission. Thus, the argument of the southern states that they will suffer major losses due to inclusion of population 2011 in tax devolution is not justified. This debate targets most of the backward states like Bihar, Uttar Pradesh (UP), Rajasthan, Madhya Pradesh and so on. Among these states, Bihar lies in the lowest rung.

Upholding the spirit of federalism, a finance commission should function as an intermediary between the union and state governments. The finance commissions can neutrally redress fiscal inequalities only if the union and state governments decide jointly on its constitution and ToR. The Constitution provides for the necessary institutional framework, financial and functional division of responsibilities between the union and the states, and a defined mechanism for intergovernmental transfer to address the existing vertical and horizontal imbalances. To address these imbalances, the finance commissions have been given a constitutional mandate to decide on: (i) the proportion of tax revenue to be shared from union to the states and among the states; and (ii) the principles which should govern the grants-in-aid to states; and (iii) other issues which are reckoned as important to the finance commission. In this backdrop, this paper attempts to address the latest devolution through the Fourteenth Finance Commission, with respect to Bihar, to represent the case of most of the backward states in the country.

Historical Backdrop

Bihar has suffered from a long history of discrimination which started in the colonial period and that continues even after independence. During the colonial period, the overall Indian economy had indeed stagnated, except a few enclaves that the British had cared to develop—port cities and defence centres. Unfortunately, being a landlocked state, Bihar neither had any port nor any major defence base station: Bihar remained one of the most neglected regions of colonial India. Along with this, other factors leading to the backwardness of Bihar during the colonial era was the character of land settlement such as the Permanent Settlement, in which the zamindars extracting rent were the middlemen. After independence also, the regional development strategy of the central government implied continued negligence of the economic interest of Bihar, for example, the Freight Equalisation Policy. This policy ensured that the two basic inputs for industrialisation (coal and steel) were made available throughout the country at the same price, ignoring their freight costs, which had a negative impact on the economy of Bihar. It actually accentuated the extant inequality in the regional distribution of industrial growth. Consequently, the already industrially developed regions did not have to face the cost disabilities owing to their distance from the location of sources of key inputs and, on the other, regions like Bihar had to face the historical disadvantage of having poor industrial infrastructure. Finally, the last knock on the economy was the bifurcation of Jharkhand in 2000 which left Bihar with 75% of population and 54% of land. Along with this, in terms of net value added for erstwhile Bihar, the share of present Bihar was only 17.9% as against 82.1% for Jharkhand. With nearly all the minerals remaining with Jharkhand, the contribution of mining and manufacturing sectors to gross state domestic product (GSDP) of the state has dropped.

Bihar Budget

Proper management of finances is a prime requirement of an economically backward state like Bihar. Such management generates confidence by strengthening the government’s capacity for policy implementation. Allocation of resources to different activities strictly according to economic and social priorities and monitoring the outcome of all public expenditure are essential functions of any government. In this direction, the state government has already made some significant progress by improving the quality of expenditure and increasing the overall revenue, including its own sources. The capital outlay has continuously increased for the much-needed investments in social and physical infrastructure. Table 1 shows the increase in total receipts between 2006–07 and 2016–17. From the table, it is evident that the state is prudently managing its financial affairs. An increase of sixfold in own tax and fivefold in total revenue receipts, fortifies the fact.

For Bihar, the dependency on the central devolution for meeting its expenditure needs is very high. Around 52.2% from tax devolution and 20.6% from grants-in-aid came to the state in 2006–07 as per finance commission’s recommendations. During these 10 years, due to high growth rate registered in own revenue, the dependency on central transfers has declined by almost 10 percentage points. In 2016–17, 46.3% of revenue came from the centre as state’s share in divisible taxes and 16.2% as grants-in-aid (Figure 1). The state has shown efficient resource management, even though it is one of the lowest tax–GSDP states (Economic Survey of Bihar 2017–18).

The state has honestly followed all the targets meant for fiscal consolidation by making its level of expenditures compatible with the targets fixed by Fiscal Responsibility and Budget Management (FRBM) Act, 2003 guided by the Twelfth Finance Commission and the Fourteenth Finance Commission. As seen from Table 2, between 2006–07 and 2016–17, there has been a sixfold increase in plan expenditure, denoting a 13.6 percentage points increase in the share. Revenue expenditure shows an increase of 4.6-fold and capital outlay of 5.2-fold in the span of 10 years. It is appreciable that in these 10 years, the increase in capital outlay is more than revenue expenditure. Optimum utilisation of scarce resources is the need of proper budgeting which is proved by planned expenditures and accurate foresights of earnings. Not only this, the state has also maintained fiscal discipline by keeping its fiscal deficit less than 3% of the GSDP; the debt–GSDP ratio is also kept under limit; and interest payments are less than 10% as per recommendations of different finance commissions. Thus, it is proven that Bihar has truthfully followed all the steps needed for fiscal consolidation of the state.

Centre–State Relations

The Seventh Schedule (Article 246) of the Constitution delineates “the subject matter of laws made by the Parliament and by the Legislatures of the States” and for these three sets of powers have been constituted. One for the entire nation which includes all those subjects that are in the exclusive jurisdiction of Parliament (List I). Next, for the state governments which consist of all the subjects that are under the exclusive jurisdiction of the state legislature (List II), and the last one on which both Parliament and the state legislatures can pass laws (List III). The Constitution clearly demarcates subjects that are under the exclusive domain of the union and those under the states. The autonomy of the state is very important for the proper functioning of a federal system. States in India have been plagued by recurrent and severe financial crises from the mid-1980s. Mismanagement of the finances by the state governments is the reason for the crisis, most often highlighted during various discussions. The role of the central government, pivotal under the existing centre–state pecuniary relationship, is seldom mentioned as a possible reason, though it has been well established that Indian federal state is only a semi-federal one and the existing constitutional allocation of financial powers between the centre and the states is heavily skewed in favour of the former. The Constitution places considerable constraints on the states’ capacity for resource mobilisation while saddling them with enormous expenditure responsibilities. The Constitution of India, however, envisaged a rather unique fiscal transfer mechanism to transfer adequate funds from the central government to the states, taking into account the disproportion between the financial powers and expenditure responsibilities of the two tiers of the government.

Thus, to create a fiscal-federalism structure where the states have greater revenue-raising authority, as well as greater decision-making power on spending, implies a lower reliance on the union government in fiscal matters as well as governance decisions. It also means reducing the power, if not eliminating, of the union government in receiving a large proportion of all revenue, and then allocating that revenue among the states.

Growth and Human Development

Bihar has a glorious history. But due to political and socio-economic changes, Bihar lost the tug of war for development. Today, Bihar is striving at the lowest rung of development and considered as an underdeveloped state with a per capita income of `26,693 in 2016–17 which is 5.4 times less than the income of Haryana (`1,43,211) and 4.9 times less than the income of Maharashtra (`1,31,139). However, as Table 3 show that over the period of 10 years, there has been a tremendous change in state’s performance. In economic indicators like GSDP and per capita income, there is almost a fourfold increase, while the social indicators like total fertility rate, infant mortality rate, maternal mortality rate, etc, shows decline over the period. On the other hand, there is an increase of 16.8 percentage points in literacy, 91.2 sq km in road density and 172.1 kwt in per capita electricity consumption.

Even after so many hurdles, the state has managed to maintain a real growth rate of 10.52% during 2005–06 to 2014–15. In the recent past, the growth rate of GSDP was 7.5% (2015–16) and 10.3% (2016–17) which are still higher than the national average of 7.0% (Economic Survey of Bihar 2017–18). This has been achieved by a higher mobilisation of internal resources by the state government at one end, and an emphasis on development-oriented expenditure on the other. However, to maintain this growth momentum in the long run, the internal efforts of the state government need to be complemented by a conscious and progressive support of the central government. The finance commission’s recommendations are obviously one of the principal means through which the central government could help Bihar and other disadvantaged states to attain their development goals and, thereby, gradually reduce regional disparity in the country and provide comparable standards of basic essential services to the citizens residing there.

The state is committed to social development and in recent years, it has achieved signifi­cant improvement in the health and educational status of its population. Between 2001 and 2015, life expectancy at birth increased by more than four years, infant mortality rate reduced from 62 to 42, total fertility rate dropped from 4.4 to 3.2, and maternal mortality rate declined from 400 to 208 per lakh live births. Similarly, the state has improved significantly its literacy rate during the last decade, from 47% in 2001 to 61.8% in 2011. This implies an increase of 14.8 percentage points. It is worthy to note that this decadal increase is not only the highest among all the decadal growth rates in Bihar since 1961, it is also the highest among all the states for the decade 2001–11. The progress that has been achieved in recent decades is tied intrinsically to the prudent management of scarce finances. The prospects for inclusive growth, equal access to social protection, and broader sustainable development are guided by investments in healthcare and education, and political and socio-economic stability. As a result of bifurcation, the infrastructure base of the present Bihar worsened. Although the road density per 100 sq km is higher (219 km) than the all India average (139 km), in the case of power and energy, the scenario is grim with per capita power consumption being 258 kwh, as against the national average of 1,010 kwh (2014–15).

Finance Commissions: Terms of Reference

The commission constituted by an order dated 22 November 1951 listed the functions of the commission under Article 280 and provides the basic ToR of the finance commission. The finance commission is a constitutional body formed every five years. The Finance Commission is required to make recommendations on: (i) sharing of central taxes with states, (ii) distribution of grants-in-aid to the states, (iii) measures to augment the Consolidated Fund of a state to supplement the resources of panchayats and municipalities, and (iv) any other matter referred to it. The ToR given to different finance commissions as embodied in the respective presidential orders have thus the above matters in common. Table 4 represents the ToR of the First Finance Commission to the Fourteenth Finance Commission.

Progressivity of Tax Devolution

The shares of major states in the total devolution through the last three finance commissions are shown in Table 5 (p 41). It is seen that the share of tax devolution is higher for low income states compared to the richer ones. Thus, the finance commission is also addressing the issue of progressivity along with equalisation and efficiency. But, the only issue that we need to ponder upon, is the reduction in the degree of progressivity. This can be cited well by the indifference towards Bihar which is very much evident by the shares in tax devolution through the last three finance commission transfers. It could be seen that in the central divisible pool, Bihar’s share decreased from 11.028% during the award period of the Twelfth Finance Commission to 10.917% in the Thirteenth Finance Commission and again to 9.665% in the award period of the Fourteenth Finance Commission. Similarly, share in service tax also declined from 11.173% to 9.787% in between the Twelfth Finance Commission to the Fourteenth Finance Commission, so issue of progressivity can only be addressed through per capita tax devolution.

Grants

Grants are another important component of central transfer from the centre to the states. Grants to the states are disbursed in three ways. The first is the statutory transfers made on the recommendation of the finance commission; second, the assistance given for plan purposes by the Planning Commission; and third, individual central ministries give an outlay on specified services in the states as desired by them. These Central Plan Schemes (CPS) and Centrally Sponsored Schemes (CSS) are specific purpose transfers with or without matching requirements and are included in the plan schemes. Plan transfers from the union to the states consist of Normal Central Assistance (NCA),1 CSS, Additional Central Assistance (ACA),2 and under Special Central Assistance (SCA).3 The NCA transfers are under the Gadgil–Mukherjee Formula based on population (60%), per capita income (25%), efforts (7.5%) (tax, fiscal and national objectives) and special problems (7.5%). So, out of all the grants, only NCA was formula-based, whereas other grants are discretionary and arbitrary in nature. However, with the dismantling of the Planning Commission, the distinction between plan and non-plan has been abolished and in continuance, now the NCA is not in existence.

Criteria of Devolution

Vertical devolution (devolution of funds from centre to states): Unprecedented hike by the Fourteenth Finance Commission of 10 percentage points compared to the Thirteenth Finance Commission was a bold step. This increase was a compositional shift from overall central devolution, including non-finance commission devolutions. An increase in the progressive devolution and decrease in arbitrary grant is a more rational and a welcome step, especially for bridging the regional disparity. The increase is serving the twin objectives of augmenting the flow of unconditional transfers to the states and yet leaves appropriate fiscal space for central government to carry out specific purpose transfers to the states. This leads to enhancement of fiscal autonomy of the states as well.

Horizontal devolution (devolution of funds among the states): The main objective of horizontal devolution is to mitigate fiscal imbalances between the states. If we analyse all criteria of the Fourteenth Finance Commission from the perspective of Bihar, the income distance and demographic change are welcome steps. But the selection of criteria like area, in 1971 and forest cover is responsible for the decline in state’s share. Giving 10% weightage to demographic change on the basis of 2011 population is laudable, but instead of giving 17.5% weightage to 1971 population, the commission should have taken the 2011 population allotting 27.5% weightage altogether so that the states with a high burden of population cannot be penalised for 45 long years. It is evident from the economic theory of backward economies that population growth is a common phenomenon for less developed regions and not their choice. Further, selection of forest cover as a criterion was a major blow to the state because the share of forest has been barely 0.92% of India. The ToR of the Fourteenth Finance Commission mandated the need to balance management of ecology, environment, and climate change consistent with sustainable economic development. But forest cover alone cannot represent ecology, environment and climate change. Thus, along with forest cover the commission should have considered incremental green cover or waterbodies so that the criteria are comprehensive in themselves. Table 6 (p 41) shows devolution criteria in four recent finance commissions.

Who Benefited?

The finance commission is meant for equalisation of public services across the states. So, according to the principle, the backward states should get higher share compared to developed states. But the real scenario is quite different, if one compares the increase of total transfers during the Thirteenth Finance Commission and the Fourteenth Finance Commission. The states which are developed in socio-economic fields and have high per capita income like Maharashtra, Kerala and Punjab are in the list of most benefited states and are gaining most (187%) compared to other developing states. Similarly, states like Haryana and Gujarat are included in the list of average benefited (174%) and, except Tamil Nadu, all states in the least benefited list are poor states like Bihar, UP, and Rajasthan that have low per capita income and are getting the lowest share (140%). Nevertheless, this does not fulfil the objective of the finance commission. Table 7 shows the true picture of the real beneficiary states.

Terms of Reference of the Fifteenth Finance Commission

The ToR of the Fifteenth Finance Commission is entirely different from the other ToRs. Along with the general recommendations under Article 280, the ToR also requests the Fifteenth Finance Commission to consider the demand of the states for financing socio-economic development and the central government regarding payment of compensation for goods and services tax (GST) for possible loss of revenues for five years, and the fund requirement for national development programme—India 2022. The ToR also proposes that the commission consider efforts made by state in expansion and deepening of tax net under GST, moving towards replacement rate of population growth, implementation of flagship schemes of the Government of India, disaster resilient infrastructure, sustainable development goals, and quality of expenditure, incurring expenditure on populist measures and progress made in sanitation, solid waste management and bringing in behavioural change to end open defecation. Thus, by means of these provisions, it is evident that the Fifteenth Finance Commission has been asked to provide incentivising grants to the states which have implemented these programmes efficiently. But for backward states like Bihar with poor infrastructure and unskilled human resources, first, these performance-based initiatives will be more penalising. Second, ToR’s measurable performances should not be asymmetric, that is, applicable only for the state governments. It ignores the fact that it is also the responsibility of the central government to broaden and deepen the base of GST, increase tax and non-tax revenues, make progress in properly targeting huge volume of subsidies, or improve the ease of doing business. Third, the incentives given to the states should be need-based or a combination of both need and performance.

Further, the commission shall use the population data of 2011 while making its recommendations (ToR the Fifteenth Finance Commission). This issue was highly criticised by the southern states, because they believed that it would result in lower resource allocation to the southern states. The 1971 population figures showed a dramatic increase in population, after which the concept of family planning was introduced at the policy level. (This meant that states that complied with the policy would lose out on all the areas where population was taken into account. Hence, the 42nd Amendment picked the 1971 Census as the base for all calculations and froze it till the 2001 Census.) The demographic transition that the southern states have achieved is indeed commendable, but some states in the north (for example, West Bengal and Punjab) have also achieved the same and others are gradually following them. Thus, the use of population data of 1971 would only mean ignoring the current reality and a staggering penalty for socially disadvantaged states for 45 long years. Finally, let it also be noted that ToR provides incentives for the “efforts and progress made in moving towards a replacement rate of population growth” which will undoubtedly reward those states, both in the South and North, that have attained demographic transition (PTI 2018). In addition, for higher inclusive growth in the country, as per the principles of finance commission, “equality, efficiency and transparency” is one that creates opportunities for all geographical regions and segments of the population. In this perspective, it is high time to use the latest population figures.

Expectations from Fifteenth Finance Commission

The Fifteenth Finance Commission is unique as this is the first commission after the abolition of plan period and GST reforms. Previously, resources were also devoluted by the Planning Commission but now the finance commission is the only source of devolutions apart from CSSs. So, all the states, including Bihar, have great expectations from the Fifteenth Finance Commission. The constitutional directive of the finance commission is determination of resources and expenditure and distribution of divisible pool among the union and the states to reduce the regional inequality. Unfortunately, over the last 70 years, instead of bridging the regional disparity, the gap has widened in socio-economic perspective. Any change in the finance commission devolutions has greater impact on backward states like Bihar, for example, between the Thirteenth Finance Commission and the Fourteenth Finance Commission, Bihar has suffered a loss of 1.3 percentage points, due to reduction in the share of divisible pool from 10.917% to 9.665%. This will add up to a loss of `51,326 crore for the state. For choosing the criteria of horizontal devolution, the Fifteenth Finance Commission should consider that the backward states are not losers as previous commissions, because the objective of the finance commission is to address the issue of regional disparity. Among all the institutions, either constitutional or unconstitutional, the finance commission is the only institution that addresses the goal of equalisation to some extent.

Thus, in order to address regional disparities, the Fifteenth Finance Commission must take care of a few things like expansion of green cover,4 instead of forest cover and special consideration for states who have faced the financial shock after bifurcation.5 Along with this, the central government should think about the sharing pattern of CSSs.6 Also, the states should not be punished for following the FRBM norms. It was mandated in the recommendation of the Fourteenth Finance Commission that states should follow fiscal consolidation norms. As per the Fourteenth Finance Commission,

fiscal deficit of all States will be anchored to an annual limit of 3 per cent of GSDP. The States will be eligible for flexibility of 0.25 per cent over and above this for any given year for which the borrowing limits are to be fixed if their debt-GSDP ratio is less than or equal to 25 per cent in the preceding year. States will be further eligible for an additional borrowing limit of 0.25 per cent of GSDP in a given year for which the borrowing limits are to be fixed if the interest payments are less than or equal to 10 per cent of the revenue receipts in the preceding year. The flexibility in availing the additional limit under either of the two options or both will be available to a State only if there is no revenue deficit in the year in which borrowing limits are to be fixed and the immediately preceding year. (Fourteenth Finance Commission: 201)

Further, the same commission recommended,

we have primarily relied on tax devolution to cover the assessed revenue expenditure needs of the States. It is only in the case of some States that we had to give revenue deficit grants to cover their revenue expenditure requirements after assessing their post-devolution revenue deficits derived from their projected fiscal capacities and needs. (Fourteenth Finance Commission: 18)

Thus, the recommendation of the Fourteenth Finance Commission is contradictory. The same commission (the Fourteenth Finance Commission) is doing advocacy for revenue surplus by restricting the states to keep their fiscal deficit within the limit of 3% of GSDP and in contrast, it is also awarding the states by revenue deficit grants for not following FRBM norms. So, this negation should be resolved and states with better performance under FRBM should not be penalised for following the fiscal consolidation road map. However, the inclusion of population 2011 in the ToR after 50 years is a welcome step in this direction.

Conclusion and Suggestions

The dilemma of cooperative federalism brought by the Fourteenth Finance Commission and renewed impetus for the states to have larger control over their desired fiscal direction, priorities, and areas of improvement, needs to be sorted out. In reality, the allocation pattern of finance commissions is adding up to the inequity between states. In order to strengthen the states authentically, the Fifteenth Finance Commission should give high weightage to the 2011 population and should also consider fiscal discipline. Thus, the states who have shown fiscal prudence by staying within the limits of FRBM should be awarded and not penalised. The Fifteenth Finance Commission should include income distance along with the 2011 population. Both of these should be given higher weightage to address the progressivity in tax devolution. Adding up to all these, we would like to conclude on these notes that in the context of the Fourteenth Finance Commission: (i) Each and every state, especially backward states, were benefited from vertical devolution, due to decrease in grants which are discretionary and arbitrary devolution and increase in tax devolution, which is progressive; (ii) Bihar faced a loss of `51,326 crore due to lesser share in horizontal devolution; and (iii) the Fifteenth Finance Commission should not deviate from the principle of equalisation, because the finance commission is the only body for addressing the issue of regional disparity.

Notes

1 Normal Central Assistance (NCA) is split into two parts, namely 30% allocated to the special category states to enable development in their regions, while the rest of the 70% were distributed among the general category states. Further, the NCA of special category states is divided into 90:10 ratios of grants and loan, respectively. While the ratios for the general category states were 30% grants and 70% loans. The NCA transfers among states were under the Gadgil–Mukherjee formula.

2 ACA provides assistance for externally-aided projects.

3 SCA provided for special projects/programmes and other specific projects like Border Areas Development Programme, etc.

4 Green cover is meant to enhance ecosystem services such as carbon sequestration and storage (in forests and other ecosystems), hydrological services and biodiversity.

5 Financial shock relates to those states who after bifurcation were left with more liability compared to the resources.

6 Like two types of sharing pattern of 90:10 and 60: 40 between special category states and general category states, there should be another sharing pattern of 80:20 for backward states.

https://www.epw.in/journal/2020/43/special-articles/progressiveness-finance-commission.html

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