Union State Relations and Federal system ( Part -2) - Indian Polity and Governance | Polity and Constitution (Prelims) by IAS Masters - UPSC PDF Download

• Bridge the vertical imbalances between the centre and the states by recommending adequate devolution to the states
• Promote state fiscal autonomy and efficiency
• Various reforms, on being refered by the President of India, for infrastructure and good governance.

The above role can be comprehended by looking into the recommendations of the 13^th FC(2010- 15) and the basis of the recommendations.

Federalism and Fiscal and Economic Imbalances

Vertical and horizontal imbalances are common features of most federations and Indians no exception to this. The Constitution assigned taxes with a nation-wide base to the Union to make the country one common economic space unhindered by internal barriers to the extent possible. States being closer to people and more sensitive to the local needs, have been assigned functional responsibilities involving expenditure disproportionate to their assigned sources of revenue resulting in vertical imbalances. Horizontal imbalances across States are on account of factors, which include historical backgrounds, differential endowment of resources, and capacity to raise resources. Unlike in most other federations, differences in the developmental levels in Indian States are very sharp. In an explicit recognition of vertical and horizontal imbalances, the Indian Constitution embodies the following enabling and mandatory provisions to address them through - the transfer of resources from the Centre to the States.

1. Levy of duties by the Centre but collected and retained by the States (Article 268)
2. Taxes and duties levied and collected by the Centre but assigned in whole to the States (Article 269).
3. Sharing of the proceeds of all Union taxes between the Centre and the States under Article

270. (Effective from April 1, 1996, following the eightieth amendment to the Constitution replacing the earlier provisions relating to mandatory sharing of income tax under Article 270 and permissive sharing of

Union excise duties under Article 272).

4. Statutory grants-in-aid of the revenues of States (Article 275)

5. Grants for any public purpose (Article 282).

6. Loans for any public purpose (Article 293).

Vertical imbalances are taken care of by the FC with tax devolution. It was further consolidated with the ASD since 2000 when all central taxes and duties became shareable.

Horizontal imbalances are rectified by tax devolution and the criteria adopted for the distribution among the states and UTs( each UT counts for a State for the FC and each UT gets its own funds); and the grants under Art.275.

TFC

The five member team, headed by economist Dr.Vijay L Kelkar submitted report of the Thirteenth Finance Commission to the Government and was tabled in the Parliament during the Budget session 2010. It focused on three key objectives of inclusive and‘green’growth, macro • economic stability and fiscal consolidation for both the Centre and the States particularly in view of the global recession since 2009 when the economy had to undertake fiscal expansion in response to domestic economic slowdown.

On sharing of Union taxes, the Commission recommended the share of States in the net proceeds ofUnionTaxes be fixed at 32 per cent, against the 12th FC prescribed transfer of 30.5 percent, an increase of 1.5 per cent. It has also said that the total transfers to the States,, inclusive of grants, be subjected to an indicative ceiling of 39.5 per cent of the gross tax revenues of the Centre.

The Commission has recommended a grant of Rs 51,800 crore for eight States that have a revenue deficit chronically(Art.275).

With elementary education at State level remaining a problem area, the Commission has accorded a grant, based on the Sarva Shiksha Abhiyan norms, Of Rs 24,068 crore.

In a bid to de-carbonize development in line with growing interests in promoting green growth, the Commission favoured a grant of Rs 15,000 crore, each Rs 5000 crore for forest grant, promotion of renewable energy and for water sector. As there remains a gap between outlay and outcome due to deficiency in delivery mechanism or designing of proper schemes to help the needy, the Commission recommended six grants for improving outcomes, amounting to Rs 14,446 crore over the award period. An incentive grant for reduction in infant mortality of Rs 5000 crore is to be released to States starting 2012-13 depending on the reduction in infant mortality rate (IMR) achieved by the States with reference to the baseline level of2009-10 figures. Grant of Rs 5000 crore for improved delivery of justice has been proposed for Lok. Adalats and Legal Aid, Alternate Dispute Resolution Centre, Heritage Court Buildings, State Judicial Academy and training of judicial officers and public prosecutors. With legal cost becoming dearer and lakhs of poor people denied access to justice, this move would help address the aberrations and anomalies in the system. Other components under this include, Rs 2989.10 crore for the Unique Identification (U!D) programme based on the number of people covered under the UD1 database, two grants of Rs 616 crore eaeh for District Innovation Funds and ' improving statistical systems at district and State levels and a grant of Rs 225 crore for setting up database of employees and pensioners. There are also grants for the requirement of roads in a State amounting to Rs 19930 crore for four years of the award period beginning 2011-12.

Finally, under grants, the Commission has provided Rs 27,945 crore for various State-specific needs of the States.

The above grants were recommended by the 13^th FC as their terms of reference include the need to improve the quality of public expenditure to obtain better outputs and outcomes and the need, to manage ecology, environment and climate change consistent with sustainable development.They are connected to fiscal management as they have growth implications and thus fiscal consequences.

On the Goods and Services Tax (GST), the Commission has put in place a model GST structure that includes features such as single rate of 12 per cent of goods and service tax, zero rating of exports, inclusion of various indirect taxes at the Central and State level in GST ambit, major rationalization of the exemption structure. It has recommended a grant of Rs 50,000 crore for implementation as per the recommended model.                                             •

On fiscal consolidation, the Commission has drawn a roadmap for fiscal deficit reduction and spelt out a combined debt target of 68 per cent of GDP, against 75 per cent'in 2009-10. It has stressed the need for achieving and maintaining revenue account-in balance and containing the fiscal deficit to 3 per cent of Gross State Domestic Product (GSDP) for the respective States by 2014-15.

An important recommendation that might satisfy the interests of States relates to its proposal allocating revenues arising from the ‘fiscal commons’ such as ‘profit petroleum, profit gas and revenue shares from spectrum’. Since these are national resources and must perforce be the collective disposal of the Central and all States, there is a case to yiew such non-tax revenues that were predominantly in the domain of the Centre “as being sharable between the Centre and the States collectively”. In order to execute this proposal it needs to be included as a pait of the divisible pool which entails Constitutional amendment.

At a time when coalition governance has become a rule rather than an exception in national politics, the whole recommendations of the 13th Finance Commission, most of which have been' accepted by the Government, would go a long way in reducing the federal trust deficit and bring about good governance and national welfare.

Any FC adopts certain criteria with respective weights for giving to the states and the UTs their individual share from the total quantum that they are accorded from the net proceeds. For example, the TFC under Vijay Kelkar recommended for the states and UTs 32% of the total. The issue is which state gets how much. That is decided by the criteria and weights. Fiscal capacity distance is the criterion that replaces the earlier criterion of per capita income- the state that has the least per capita income is given the maximum share. Therefore, it is called the ’inverse of per capita’- the lower the per capita the more the share. Fiscal discipline measures the improvement in the financial performance of each State during during a certain period over a selected base year in terms of the ratio of its own revenue receipts to total revenue expenditure- essentially how effective is its tax effort; how much is its borrowing and how wasteful or. otherwise its expenditures.

Criteria and Weights adopted by the TFC

• Population in 1971-25.0%
• Area-10.0%
• Fiscal Capacity Distance -47.5%
• Fiscal Discipline- 17.5%

FC and Performing states

FC has so far taken into consideration regional equality and the need to bridge it, as one of the objectives of the recommendations. The criteria of per capita income and Grants in aid(Art.275) are used to assist the economically backward states. Developed states have made the following three arguments against it

• It punishes performance and laggards are helped at their expense
• The moral hazard is that it incentivizes backwardness
• Such FC recommendations have not helped and inequalities and imbalances persist and have become worse.                                                                           ,

The answer of the FC is: Indian federation can be stable and be sustained only if all regions and states enjoy an element of regional balance for which FC has an obligation. Secondly, if regional imbalances persist, it is because of other structural factors like not attracting investment etc.

It must also be recognized that the leading states develop when the savings of the laggards are used for the trade and industrial development of the leaders. Also, cheap labour from all over the country fuels development of the so called performing states.

Finally, the criterion of fiscal discipline encourages better performance and has no bias.

FC and Planning Commission

Green Federalism

The Constitution of India has generally remained silent on the environmental issues in Indian federal system. In the original Seventh Schedule of the Constitution, all the natural resources - land, water, forests and minerals - were assigned to the States, while the central government was given the responsibilities to regulate the development of mines and mineral resources.

Constitution made separate arrangements for resolving inter-State disputes on sharing of river water among the States. The 42nd Constitution (Amendment) Act 1976 amended the Seventh Schedule to include 'Forests' and 'protection of wild animals and birds’ in the Concurrent List, thereby enabling a formal role of the central government on the subject.

The Ministry of Environment and Forests came into existence in 1980 and starting with the Forest Conservation Act, 1980, several measures have since been initiated by the Government to protect and manage the environment. These include the Environmental (Protection) Act, 1986; Air (Prevention and Control of Pollution) Act, 1^81; Water (Prevention and Control) Act, 1974; as well as certain rules viz. Hazardous Wastes (Management and Handling) Amendment Rules, 2003 and Ozone Depleting Substances (Regulatiomand Control) Rules, 2000. These powers were exercised by the Parliament under Art.253.

Apart from the jurisdictional issues there are larger issues of governance, research, resources and capacity building to deal with the complex issues of environment management, which cannot be handled by just one layer of government, but requires sustained efforts of all the three layers of governance - national, state and local - and involvement of all relevant stakeholders in the process. ’Green Federalism' refers to the holistic management of all these issues of environmental matters. Federal countries around the world are facing new challenges and opportunities to deal with the issues of environment and therefore sharing of knowledge and experiences among the federal countries shall be mutually useful and beneficial.                           .

14^th FC

Union Government in January 2013 constituted the 14th Finance Commission under former Reserve Bank of India (RBI) governor Yaga Venugopal Reddy. The commission under YV Reddy is going to primarily review finances of the governments keeping in mind the fiscal consolidation road map that was laid out by his predecessor Vijay Kelkar, the head of 13th finance Commission.The Commission would have three full-time members-

• Sushma Nath
• M. Govind Rao
• Sudipto Mundle

It has Prof.Abhijit Sen , the Member of Planning Commission as its part-time member. Also, Ajay Narayan Jha had been appointed Secretary to the Oommission.The commission has to give its report by October 2014 and the recommendations will come into effect from April, 2015 for a five-year period.

Terms of reference of the 14th Finance Commission-The FFC is asked 0 suggest changes to the Fiscal Responsibility and Budget Management (FRBM) Act, assess the impact of the proposed goods and services tax (GST) on government finances and also the mechanism to compensate states for revenue losses, if any. The FFC has also been asked to look at the need to insulate the pricing of public utility services - drinking water, irrigation, power and public transport from policy fluctuations through statutory provisions. FFC has also been asked to look at the level of subsidies needed for inclusive growth, and equitable sharing of subsidies between the Centre and the states.                                                                                   .

Fiscal Federalism

.The fiscal relations between the Centre and the States have been defined under the Constitutional provisions of distribution of revenues between the Union and the States.

Under the scheme of distribution of taxing powers, the major sources of revenue assigned to the Union are: taxes on income other than agricultural income; customs duties including export duties; excise duties on goods manufactured in India except alcohol and liquors for human consumption; taxes on capital value of the assets, exclusive of agriculture land, of individuals and companies; taxes on the capital of companies; estate duty and succession duty in respect of property other than agricultural land; etc.

The major sources of revenue allocated to the States, on the other hand, are: land revenue; taxes on agricultural income; succession duty in respect of agricultural land; estate duty in respect of agriculture land; taxes on land and” buildings; taxes on mineral rights; excise duties on alcoholic liquors for human consumption; sales tax; professional taxes; taxes on the consumption of electricity; taxes on advertisements; etc.

While the resources of the States are limited, they have larger responsibilities for social, educational and economic development of the people. Further there are wide differences in the level of development of the States. In order to address the issues of this vertical and horizontal imbalance in the Centre-State and inter-State relations, the Constitution of India has provided for inter-governmental transfers through the mechanism of Finance Commission which is constituted once in five years to recommend transfers of central revenue to the States for a five yearly fiscal cycle. Thirteen such Finance Commissions have been set up so far.

Further such transfers also take place through the Planning Commission. There are three main channels of Central transfers to States; the finance commission transfers, plan transfers and assistance for central sector and centrally sponsored schemes. Today such transfers constitute about 44 per cent of state's total revenues, 42 per cent of the state's current expenditure; and almost 36 per cent of the revenues collected,by the central government.

The figures show that the transfers have grown at a faster rate than the revenues collected by both the centre and the States. Still the resources available to the States have not been found adequate for discharging the responsibilities of the State governments.

Centre and states are having friction in the financial relations based on the following issues:

1. Gst
2. FD1- MBR
3. Royalties for minerals
4. Centrally sponsored schemes

Cooperative Federalism

Although the Constitution of India has nowhere used the term 'federal', it has provided for a structure of governance which is essentially federal in nature. First of all, Constitution has provided separate governments at the Union and the States with separate legislative, executive and judicial wings of governance. Secondly, Constitution has clearly demarcated the jurisdictions, powers and functions of the Union and the State Governments. Third, Constitution has spelt out in detail the legislative, administrative and financial relations between the Union and the States.

Within this basic framework of federalism, the Constitution has given overriding powers to the Central government. States must exercise their executive power in compliance with the laws made by the Central government and must not impede on the executive power of the Union within the States. Governors are appointed by the Central government to oversee the States. The Centre can even take over the executive of the States on the issues of national security or breakdown of constitutional machinery of the State.

Considering the overriding powers given to the Central government, Indian federation has often been described as 'quasi-federation', 'semi-federation', 'pragmatic federation^ a 'federation with strong unitary features'.

Indian federation should be seen in the context of its democratic system of governance at the national, state and local levels and the pluralities of its culture in terms of ethnic, linguistic, religious and other diversities which cut through the States. India is the largest democratic country as also the largest federal and the largest pluralist country of the world. While democracy provides freedom to everybody, federation ensures that governance is distributed spatially and a strong central government enables that the 'unity amidst diversity’ is maintained and the country mobilizes all its resources to maintain its harmony and integrity and marches ahead to progress.

A strong Centre in India is therefore necessary for strong States and vice versa. Since the seventies when different political parties are in power in the centre and the states and more recently when national parties were eroded.and coalition governments became the norm in the Centre, there are signs of stresses and tensions in intergovernmental relations between the Centre and the States.:

The federal challenges in the country today requiring cooperation include national security( NCTC etc), food security, inflation management, education, land acquisition and so on.

Article 263 of the Constitution has provided for the setting up of an Inter-State Council for investigation, discussion and recommendation for better coordination of relation between the Centre and the States. The Zonal Councils set up under the State Reorganization Act 1956 provide another institutional mechanism for centre- state and inter-state cooperation to resolve the differences and strengthen the framework of cooperation. The National Development Council .and the National Integration Council are the two other important forums that provide opportunities for discussion to resolve differences of opinion. Central councils have been set up by various ministries to strengthen cooperation. Besides Chief Ministers, Finance and other