The government’s acceptance of the recommendations of the 14th Finance Commission (FC) signifies its intent to fix its finances as well its determination to change the development paradigm. The FC has recommended an increase in the share of states in the Centre’s tax revenue from the current 32% to 42%—the single largest increase ever recommended. It will give more power to states in determining how they spend this money. This is in line with Prime Minister Narendra Modi’s thrust on cooperative federalism that advocates involving states in the Centre’s decision making.
The States’ involvement is critical, particularly for a country like India, where some pockets compare with the world’s richest nations, while many others can match up only to the poorest countries of sub-Saharan Africa. Given India’s rapidly changing urban and rural economic landscape, the involvement of states will help policy markets in New Delhi uncover growth opportunities identifying geographic slivers of opportunity — states, metropolitan cities and their hinterlands.
The FC sets tougher targets for the Centre: It wants the fiscal deficit reduced to 3% of GDP by 2016-17. Fiscal management was critical to push economic growth, equity and stability, including price stability, the report said, adding that both the Centre and states would have to play an equally important role in maintaining fiscal discipline.
Politically, the increase in devolution could also serve as a confidence-building measure, particularly relevant given that the Centre and states are negotiating the introduction of a single goods and services tax (GST) under which the latter will forgo most of their taxation powers. Once implemented, GST will stitch together a common national market by subsuming a welter of local levies such as octoroi, VAT and others into a single tax. Its implementation has faced political hurdles because states fear it will rob them of their fiscal powers. The greater transfer of funds and the resultant fiscal empowerment could well be a grand bargain for rolling-out GST.