Constitution of the Sixteenth Finance Commission
Context:
- The establishment of the Sixteenth Finance Commission won’t take long. There have been multiple significant developments since the establishment of the 15th Finance Commission, which includes COVID-19, in November 2017 and the accompanying geopolitical difficulties.
Vertical and horizontal dimensions are:
- The Fourteenth Finance Commission increased the percentage of States’ share of federal taxes from 32% to 42%.
- This was changed to 41% when India’s states were reduced from 48 to 28.
- From 2015–16 to 2019–20, the effective proportion of States in the Centre’s gross tax revenues (GTR) was over 35%; from 2020–21 to 2023–24, it averaged just over 31% (BE).
- This was brought on by the disproportionate increase in cesses and surcharges, which went from 12.8% in the years from 2015–16 to 2019–20 to 18.5% in the years from 2020–21 to 2023–24.
- The widespread usage of cesses and surcharges must be looked into by the Sixteenth Finance Commission. The cesses and surcharges part could be set at a minimal level.
- Concern has grown over the past few years due to the poor performance of the Goods and Services Tax (GST) and the resulting decline in the overall divisible pool. Fortunately, this issue has been resolved as GST receipts have been steady over the previous two years. GST still has to be reorganized to become a beneficial and simple tax.
- The parameters used to determine each State’s share of the Centre’s distributable pool of taxes include population, per capita income, area, and incentive-related factors like forest cover and demographic change.
- The per capita income of a State is calculated as a percentage of a benchmark, which is typically the average per capita income of the top three States.
- However, the needs of the States with lower incomes must be properly taken into account. If the medical and educational needs of their populations are satisfied, it is projected that these States will eventually give India a “demographic dividend” that is substantially larger.
- In actuality, equalizing the provision of services for health and education should come first in the overall plan of resource transfers.
- Instead of using a large number of tax devolution criteria, the equalization principle may be used to direct the distribution of resources to individual States, using a small number of characteristics, such as population, area, and distance, supplemented by an appropriate grant program.
- The equalization principle is compatible with both efficiency and equity. In federations like Australia’s and Canada’s, it is used.
Recommendations:
- The combined debt-to-GDP ratio for the federal government and state governments reached a peak in 2020–21 at 89.8%; the federal government’s debt-to-GDP ratio was 58.7%, while the state governments’ debt-to-GDP ratio was 31%.
- These figures are still significantly higher than the corresponding Fiscal Responsibility and Budget Management (FRBM) standards of 40% and 20% as per the 2018 amendment, despite the fact that they have begun to drop.
- Additionally, it is clear that the federal government will need to make more changes than state governments.
- In comparison to their GSDPs, several State governments appear to have relative larger debt and fiscal deficit ratios.
- The expansion of subsidies and the return of the outdated pension system in States without a clear understanding of the funding sources and following fiscal repercussions are two issues that come up in this context.
Moving forward:
- One innovation that might be applicable in this circumstance is the institution of a lending council, as suggested by the Twelfth Finance Commission. This unbiased agency ought to be in charge of the loan amounts and profiles for the federal and state governments.
- The Sixteenth Finance Commission should thoroughly investigate the subject of non-merit subsidies.
- The Finance Commission recommends that states adhere rigidly to a ceiling on their budget deficit. States that continue to run fiscal deficits must be given incentives.
