Examining the Strength of Pillars That Uphold India’s Fiscal Federal System – The Wire

What causes the wealth and prosperity of a nation? The question hounded Adam Smith in 1776 and he tried to find the solution in his famous book An inquiry into Nature and Cause of the Wealth of Nation. With all the technological advancement that has taken place in the last 250 years, the question remains as relevant as ever.

In 2017, economist Amartya Sen asked the question, Whats wrong with inequality? He answered, As inequality increases, the standard of living is worse for those at the bottom of the economic ladder than it would have been without the relative inequality.

In India, the pandemic has deepened wealth concentration and inequality. Corporate tax is at an all-time low. Petrol at above Rs 80-90 per litre is the new normal. On the flip side, India has become the fifth largest economy in the world and aspires to be the third.

Vijay Kelkar postulates that Indias unique federal structure which upholds the fragmented states together is the only way to sustain such a vast and diverse country.

The architects of the Indian Constitution were optimistic; they designed federal institutions like Planning Commission, National Development Council (NDC) and Finance Commission etc. to leverage development policies. Louise Tillin argued that the ability of Indias Central government to set the economic agenda or secure implementation of national policies throughout the country depends on the institutions and practices of federalism.

Well framed economic policies lead the market to distribute resources to expand the size of the economic pie, but it might not be the same in all cases. Economists refer to this situation as a market failure, when the market fails to properly allocate resources. Sometimes an externality can be the cause of a possible market failure, which can be defined as the impact of one persons actions on the well being of the bystander. The classic example of an externality is a particular political ideology.

This concept was hammered in in 2014, with the intention to abolish planning in Narendra Modis very first Independence Day speech. On January 1, 2015, the Planning Commission was replaced by the NITI Aayog, a think tank that contracted the government policy reach which earlier was entrusted to promote regionally balanced growth in India. Simultaneously, NDC, which helps the Planning Commission in mobilising plans, stimulating a common economic agenda and ensuring robust growth, has become defunct as the composition of NDC is the same as of NITI Aayog. At present the fiscal structure of India stands on two pillars: the Finance Commission and Goods and Services Tax Council. The first is responsible for recommendations related to devolution of taxes between Centre and state and grants in aid from consolidated funds of India and latter is responsible to maintain uniformity in taxation.

For the first time, the 15th Finance Commission recommended 42% of total tax collection to go to states while the Union will take 58%, and 1% from the states share will go to the newly carved union territories of Jammu and Kashmir and Ladakh. The Centres share is meant for obligatory responsibility such as maintenance of defence, but the 15th Finance Commission has paved the way to gulp the state share meant for distributable statutory grant against the very ideal of tax share under constitution the commission is responsible for devolution of taxes and statutory commitment not to bear the burden of Centres expenditure.

Although, the amount cost only 0.5% of the total share of 14 lakh crore to the states, it is act to take a drop from the state share and eventually dry the same and shift the equilibrium toward the Centre which challenges the ideal fiscal structure of India. This phenomenon jeopardises states in financing their own welfare schemes. India is a union of uneven developed states, due to revenue crunch dependency of states increase towards the Centre, the situation for the state will be miserable if the government at the Centre does not support the same ideology. It will even be difficult to meet the required share of money in centrally sponsored schemes.

The second pillar is the Goods and Services Tax (GST) Council. Arun Jaitley, the then finance minister, claimed that the GST Council is the first federal institution of India, which is not because no single state would have the freedom to decide a different tax rate on a particular good or service as per their necessities. In the absence of a tax rate deciding authority, states become collecting agents who get commission in the form of incentives provided in the horizontal division of Finance Commission. This mechanism restricts state governments to frame and follow their own fiscal policy. Narrow revenue source states cannot undertake welfare schemes.

It was pretty evident during the initial months of the pandemic when the revenue sources of the Centre as well as the states dried up and the Centre failed to meet its collection targets and couldnt even meet its past compensations let alone this years shortfall. States couldnt independently pursue preventive measures and were left at the mercy of the Centre. Later on, the Central government came up with extended borrowing provisions which drew flak from various states due to its discriminatory nature. Incontrovertibly one nation one tax has left states fund starving during emergencies and has dismantled Indias fiscal federalist structure.

For instance, the GST council under Article 115 exempts liquor and petroleum products from GST ambit since these two are the main source of revenue for the state. First liquor was completely banned in the state of Bihar. Prohibited production and consumption of liquor cost Rs 4,000 crore (estimated) to exchequer. It makes the situation worse for Bihar where 43% children (under five years) are stunting. The state ranks lowest on the Human Development Index with its distressing performance in health indicators, economic indicators and education indicators. The second source of revenue is petrol and diesel. The Union government has increased the central excise duty, cess and surcharge. VAT charges on petrol and diesel in Bihar is lower in comparison with other states. Bihar charges only 26% or Rs 16.65/litre, whichever is higher (30% of VAT on surcharge as irrecoverable). Nineteen percent or Rs 12.33/litre, whichever is higher (30% of VAT on surcharge as irrecoverable) while Rajasthan charging the highest VAT 36% VAT+Rs 1500/KL road development cess and 26% VAT+ Rs.1750/KL road development cess respectively on petrol and diesel.

Indias federal institutions were meant to make a balance between low performing states and high performing states. Supreme Court in Kesavananda Bharti case (1973) held that no amendment of Indian Constitution violates the basic structure of constitution and federalism is one the basic features of the Indian constitution which cannot be dismantled.

Recently Manmohan Singh said that Indias constitution is unique because of federalism and regular consultation with states, which was the cornerstone of Indias economic and political philosophy, no longer finds favour with the present central government, these lines clearly describe the current situation. The tendency of over centralisation is pernicious to the symmetry between Centre and state. The balance was established not only in administrative, legislative but also in the fiscal matter. Every attempt to destabilise fiscal harmony in that sense is unconstitutional. Falling of any pillar of fiscal federalism will crumble the essence of Indian union visualised by the architect of constitution.

Utsav Kumar Singh works as an Assistant Professor at Shaheed Bhagat Singh College, University of Delhi, University of Delhi

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Examining the Strength of Pillars That Uphold India's Fiscal Federal System - The Wire