The following points highlight the four main recommendations of the Eleventh Finance Commission.
Recommendation # 1. The Imbalance of Federal Finance:
A sound system of inter-governmental fiscal transfers constitutes the cornerstone of a strong and stable federal polity. It highlights the fact that there has been a serious deterioration in the fiscal situation of the States in the 1990s, worse than what the aggregate budgetary balance figures will indicate.
The Eleventh Finance Commission has identified the predominantly structural causes for the deficit mainly due to the erosion of the tax-GDP ratio and the virtual stagnation of non-tax revenues. On the expenditure side it has critical the periodic upward revision of emoluments of government employees without adequate consideration of the ability of the public sector to bear the burden and the convergence of salary structures of Central and State governments, on the one hand, and of local governments and aided institutions on the other.
Recommendation # 2. Revenue Mobilisation:
For the first time, this Finance Commission has looked into the possible measures that can be taken for mobilising additional resources by the Centre, the States and even the local bodies. It has even suggested constitutional measures for widening the tax base. Services, the Commission suggests, should be brought under the Concurrent List and the limits for professional tax should be taken out of Article 276.
Like so many other commissions and committees, the Finance Commission has also strongly recommended the levy of taxes on farm incomes with bulk of land taxes being administered by local bodies. It has suggested that the panchayats should be made more responsible. Cess on land-based taxes and other State taxes and duties may be levied to mobilise resources for augmenting specific civic services. A 10% surcharge on sales tax, entertainment tax and State excise may give significant additional revenues which can allocated to the local bodies.
User charges for supply of basic needs such as drinking water and sanitation should be revised upward periodically.
Recommendation # 3. Sharing of Tax Revenues:
In the past various criteria have been adopted by successive commissions in deciding the allocation. The allocation formula is based on population, distance and inverse of income and index of backwardness.
The Tenth Finance Commission introduced a 5% weightage for index of infrastructure and 10% for tax effort. The population criterion has become controversial.
The Eleventh Finance Commission has reduced the relative weightage for population to 10% and for tax effort to 5%. It has raised the index of infrastructure to a weightage of 7.5%. A novel idea thrown up is the introduction of a 7.5% relative weightage for fiscal discipline.
Article 280 of the Constitution makes it obligatory on the Finance Commission to make recommendations as to the distribution between the Centre and the States of the net proceeds of taxes. This is to be distributed among the States. It is not open to the Finance Commission to go beyond the scope of Article 280 by laying down an index of fiscal discipline for division of tax proceeds. It is only in respect of grants-in-aid that the Finance Commission can lay down principles.
Recommendation # 4. Reduction of Resource Allocation:
The Eleventh Finance Commission has suggested a reduction resource allocation to Tamil Nadu, Andhra Pradesh, Maharashtra and Gujarat. Correspondingly, there will be an increase in the allocation to Bihar, Uttar Pradesh, Madhya Pradesh, West Bengal and Orissa. Of the aggregate transfers to States of Rs. 4, 34,905 crores, Rs. 2, 26,320 crores will go to them.
It is noteworthy that the Finance Commission regulates grants-in-aid of the revenues of the States under Article 275. It has no say regarding the way the Centre distributes discretionary grants under Article 282. This is taken care of by the Centre on the advice of the Planning Commission. It is necessary that the discretionary grants under Article 282 should also be brought within the framework of a constitutional authority like the Finance Commission.
The States must be given a legal right to a larger share in the tax and other revenues collected by the Centre. The levy of surcharge on taxes or the rise in administered prices without a rise in excise duties and all such devices will only go to make the States the vassals of the Centre.
The Eleventh Finance Commission (EFC) whose recommendation took effect from 2000-01 has fixed the total share of States in all taxes at 29.5%. EFC also recommended a significantly higher level of grants-in-aid to deficit States.
On the basis of revenue assumptions related to GDP growth over the five years 2000-05 the States should receive Rs. 3, 76,318 crores by way of tax devolution (or 28% of gross revenue receipts of the Centre). In addition, 1.5% of net proceeds of shareable Central taxes/duties in a year may be distributed among such States, which do not levy sales tax on sugar, tobacco, and textiles during that year. The grants-in-aid would be of the order of Rs. 35,359 crores for five years to those States, which will have deficits even after the devolution of Central tax revenues.
The EFC has laid down fiscal reforms for the Centre and States by which there should be no revenue deficit at the state level while it would be only 1% of GDP at the Centre in 2004-05. Fiscal deficit of the Centre and the States would stand reduced to 4.5% and 2.5%, respectively.
The Centre is creating pressures on the States to enter into Memorandum of undertaking which links assistance to progress with reforms. Even international financial institutions like World Bank and Asian Development Bank have focused on State-level reforms and extended loans to States undertaking economic restructuring programmes.