"Development consists of the removal of various types of unfreedoms that leave people with little choice and little opportunity of exercising their reasoned agency. The removal of substantial unfreedoms, it is argued here, is constitutive of development," writes Amartya Sen in his book 'Development as Freedom.'
The development process of any socio-political and economic institution aims to move towards modernisation, improvement in various sectors of society that lead to the overall development of the population. The 'overall development' envisages the development of India, which comprises all states and union territories. This development demands a strong balance between centralisation and decentralisation of finances between the centre and the states, including the collection and distribution of taxes and duties.
Background of the Finance Commission
Under the colonial powers, India's financial system was highly centralised, then changed by subsequent laws like the Government of India Act, 1935. Under the British colonial government and the post-independence Deshmukh Award, the Niemeyer Award was introduced to bring changes into the financial distribution system based on various factors like the states' contribution and population.
After witnessing a non-transparent and non-accountable system of finances under colonial rule, the constituent assembly realised the need to institutionalise an elaborate system, organised and categorised. This need was also amplified by the uniquely federal structure of independent India, with different states contributing differently to the nation's income. The colonial government left significant divides in the country that was not only based on religions and languages but also the financial capacities of the provinces and the princely states. The establishment of the Indian Constitution in 1950 led to a significant advancement in India's financial system. The Finance Commission was set up in 1951 under Article 280, which gave it the privileges of a constitutional body.
Like many other parts of the Indian constitution are inspired by institutions in various countries, the finance committee was based on Australia's Commonwealth Grants Commission (CGC) with some modifications.
Other articles enshrined in the constitution that elaborate upon the distribution of powers between the centre and the states regarding financial distribution are:
● Article 268 says that the Government of India shall levy taxes on services, and such taxes shall be collected and appropriated by the Government of India and the States.
● Article 269 lays down that goods and services tax on supplies in the course of Inter-State trade, or commerce shall be levied and collected by the Government of India, and such tax shall be apportioned between the Union and the States.
● Article 272 says that taxes are levied and collected by the Union and distributed between the Union and the States.
● Statutory grants-in-aid of the revenues of States is given under Article 275.
● Grants for any public purpose is under Article 282.
● Article 293 provides for loans for any public purpose.
Under Article 280(3), the main objectives of the Financial Commission include making recommendations on distribution between the Union and the States of the net proceeds of taxes, determination of principles and quantum of grants-in-aid to States which need such assistance. These recommendations under Article 281 are laid before each House of the Parliament (caused) by the President of India.
A brief analysis of the Fifteenth Finance Commission (XVFC)
Amidst the unprecedented crisis brought about by the Covid-19 pandemic, the 15th Finance Commission Report for the year 2021-26 is titled 'Finance Commission in Covid Times'. The distribution of tax revenue between the Union and the States is referred to as vertical sharing/devolution, and that among the states is called horizontal sharing/devolution. The report recommends a vertical devolution of 41%. Comparing it with previous commission reports, the recommendations stood at 29.5% under the 11th FC, 30.5% under 12th FC, 32% under 13th FC and 42% under the 14th FC.
Horizontal devolution, on the other hand, is based on factors like Population (15% weight), Area (15%), Forest & Ecology (10%), Income Distance (45%), Tax & Fiscal efforts (2.5%), Demographic Performance (12.5%). An important debate that comes into play here is that of population and the consequent tax share, a debate that has been active since the colonial period. While the weightage given to the population in the federal tax pool has reduced from 25% in the 12th FC to 15% in the 15th FC, some concerns, political or not, remain. The 15th FC has decided to use the 2011 Census against the 1971 Census used by the previous nine Commissions for their calculations. The decision to adopt the 1971 Census first appeared in Terms of Reference (ToR) of the Seventh Finance Commission in 1976. The 42nd Amendment Act froze the 1971 Census figure as the baseline figure for all population-related purposes in policy changes and was valid until 2001. The 84th amendment to the constitution extended this to the first Census after 2026, which shall occur in 2031. Thus, under this act, the 1971 figures will be used till 2031. However, the 15th FC introduced a policy change to use the 2011 census and a 15% weightage. This has seen much backlash from some states that anticipate being worse-off due to this shift from the status quo. States like Kerala, Karnataka, Punjab that have done well in terms of national population control policy have witnessed a decrease in their population under the 2011 census compared to the 1971 census. This leaves them at a disadvantage in terms of the share they get from the federal tax pool based on population. On the other hand, states like UP and Bihar, where the population has only increased from 1971 to 2011, stand at a more beneficial end due to this recommendation of the 15th FC. Some have termed this as "a punishment for implementing the national population policy."
The Finance Commission, headed by N. K. Singh, has defended this change by introducing demographic change and giving it a weightage of 12.5%. These demographic changes include areas of the economy's growth rate, structural productivity growth, living standards, savings rates, consumption, and investment in which the claiming states have done better than other states. The XVFC recommendations have also been criticised for being biased towards the centre and failing to keep up the spirit of "fiscal federalism."
The COVID-19 pandemic has exhibited the harsh realities of Indian federalism or quasi-federalism as it is popularly known. From the allocation of vaccines, oxygen plants to the allocation of funds and tax shares, the flexibility of Indian federalism is not as exemplary as it is thought to be. While the share of taxes and duties distributed by the centre to the states depends directly on each state's demand, policymakers must consider an incentive-based fiscal policy that motivates states to improve their demographic indicators. A policy that maximises cooperative fiscal federalism should be prioritised to maximise the 'overall development' of the country, which consequently maximises the benefits of the stakeholders and the actors involved.