Bridging fiscal divides

On December 31, 2023, the government appointed the Sixteenth Union Finance Commission (SUFC), with Arvind Panagariya as its chairman, in accordance with the constitutional mandate outlined in Article 280(1), which serves as the primary link between the Union and state financial relations. The main duties of SUFC are specified in Article 280(3): vertical devolution—sharing of net taxes and other funds between the Union and states; horizontal devolution—sharing the financial resources among the states; grants-in-aid under Article 275; devolution of funds to the rural and urban local governments; and any other related fiscal issues. This appointment gains significance in light of the contentious Terms of Reference (ToR) of the 15th Finance Commission, which resulted in a fiscal gap between the Union and southern states due to the use of the 2011 census explicitly for the population instead of the 1971 census, as used until the 13th UFC.

On November 29, 2023, the Union government approved the ToR for the SUFC, emphasising the functions mentioned above and expanding its scope to include financial arrangements under the National Disaster Management Act, 2005. The SUFC is entrusted with framing the actual ToR. A month earlier, on October 29, Chief Minister Siddaramaiah raised concerns about the injustice caused to the Government of Karnataka in terms of revenue loss and reduced financial devolution during the 15th Finance Commission on social media platform X (formerly Twitter).

On the platform, citizens countered the CM’s claims, asserting that tax devolution to the state increased by 148.26% and grants-in-aid increased by 129.42% between 2009–14 and 2014–19. The BJP’s Bengaluru South MP, Tejasvi Surya, highlighted that the total tax devolution during the NDA regime from 2014–2023 amounted to Rs 2.93 lakh crores, surpassing the combined devolution of taxes during the UPA I and UPA II regimes.

Recently, Chief Minister Siddaramaiah addressed these issues in an elaborate article in the Kannada daily Prajavani, focusing on the questions of equity and efficiency. Key issues highlighted included a reduction in the net tax sharing to Karnataka from 4.72% to 3.64%, causing a loss of Rs 45,000 crores to the state exchequer, and the disparity in the amount received per rupee of tax payment compared to Uttar Pradesh (Karnataka receives 0.15 paise whereas UP gets Rs 2.73). This is due to the criteria adopted to use the 2011 census for the population.

The alteration in variables/indicators used by the FFC disadvantaged the southern states, where population stabilisation and control measures were initiated. The north-south fiscal divide, both in terms of net tax devolution and the criterion used for tax devolution between the Union and states, remains a contentious issue. The argument by the southern states about higher tax contributions and lower funds received through the finance commission is valid and warrants consideration by the SUFC to improve the rationale for tax distribution among states.

Except for Tamil Nadu, all other southern states experienced a decline in their share of finances from the fourteenth to the fifteenth finance commission. Karnataka saw the highest reduction (4.7% to 3.6%), followed by Kerala (2.5% to 1.9%), Telangana (2.4% to 2.1%), and Andhra Pradesh (4.3% to 4.1%). In fact, Karnataka’s share has been on a declining trend from the eleventh (4.93%) to the fifteenth (3.64%) finance commission.

To raise and address equity and efficiency issues before the SUFC, the Karnataka government constituted a special cell consisting of economic and financial experts. Despite the state’s share increasing from 29.5% to 41% during the tenth to fifteenth FC, concerns persist regarding the criteria used for both vertical and horizontal devolution of funds. The I-X finance commissions prioritised the indicators of population, level of development, and fiscal capacity/weakness of the states. The paradigm shift took place from XI–XV finance commissions, wherein aspects of equity and efficiency were accorded priority. The challenge for the SUFC is to strike a balance between these two broad criteria and arrive at a rational basis for the devolution of taxes to accommodate the state’s grievances. The independent functioning of the SUFC without the burden of appeasement to the government in power is the vision envisaged by the framers of the Constitution. 

The functioning of the UFC’s from X-XV is largely satisfying when compared to the state finance commission under Article 243(I & Y) of the Constitution. The UFC’s work should inspire the state finance commissions with robust recommendations and their binding effect on governments. Addressing the strained fiscal relations between the Union and state governments is one of the most effective ways to strengthen fiscal and cooperative federalism. The aspects of social justice, the index of devolution, and the efforts of states in achieving SDG-1 (no poverty) need consideration from the commission, along with the issues of equity and efficiency.

(The writer is an independent researcher and writes on governance and development)