Ashok Mitra, one of India’s finest economists — his cult classic Terms of Trade and Class Relations has inspired the name of this column — was a militant defender of state’s fiscal rights vis-à-vis the Centre. Most of Mitra’s battles on the fiscal federalism front were fought in his decade-long stint as the first finance minister of the Left Front government in West Bengal which came to power in 1977. Now, as many non-BJP state governments are accusing the Narendra Modi-led Central government of undermining fiscal federalism, one wonders why we do not have a state finance minister of Mitra’s stature.
Ashok Mitra, one of India’s finest economists — his cult classic Terms of Trade and Class Relations has inspired the name of this column — was a militant defender of state’s fiscal rights vis-à-vis the Centre. (HT Archives)
The easy (and not entirely wrong) answer to this question is that it is nearly impossible for people of intellectual conviction and integrity such as Mitra to survive today’s vastly different political landscape. Mitra, himself, quit the government in 1987 after differences with the leadership of the CPI (M) in West Bengal.
However, a recent paper by economist Suyash Rai and political scientist Milan Vaishnav suggests that there could be a different reason why fiscal federalism and its champions are not getting a lot of traction currently. This reason, the authors show through their analysis of the central transfer of resources to the states, is that the BJP’s coming to power in 2014 has not led to a fall in the share of resources transferred from the Centre to the states. The numbers speak for themselves. The authors rightly follow tenures of various finance commissions — a constitutional body set up every five years and tasked with allocating resources between the Centre and the states – to track fiscal federalism. The total transfer to states, as a share of the Centre's gross tax revenues, increased significantly between the period of the 13th and 14th Finance Commission — 2010-15 and 2015-20 — from 49.6% to 58.7%. While the 14th Finance Commission’s recommendations were implemented during the Modi government’s tenure, it was set up by the Congress-led United Progressive Alliance (UPA), and as the authors correctly argue, it was a fait accompli for the Modi government.
The period when the government could have made a difference to the fiscal federalism arrangement was at the time of the 15th Finance Commission constituted under the chairmanship of N K Singh. However, the paper shows that there has been no fall in the share of resources transferred from the Centre to the states barring a minor fall in the pandemic year, 2020-21. This number stood at 61.1% in 2021-22, 60.3% in 2022-23 (Revised Estimates) and is expected to be 59% in the Budget Estimates numbers for 2023-24.
Vaishnav and Rai describe this resilience in fiscal federalism despite an increase in political centralisation as a puzzle, which their paper tries to resolve using two sets of arguments dealing with finance commission and non-finance commission transfers.
The 15th Finance Commission is seen as having pushed back despite attempts by the Central government to undermine fiscal federalism. “Unlike many other institutions with de jure independence, India’s Finance Commission has also maintained a degree of de facto independence and institutional resilience, despite apparent efforts by the Union government to influence its work,” the paper said, crediting this to various factors, including peer pressure from a small community of public finance experts.
The fact that the Centre did not even cut back on the non-finance commission grants, over which it has complete discretion, is explained by considerations of political and economic interest.
“Such schemes are politically consequential for the Union government. Reducing the amount of non–Finance Commission grants to States means risking the continuity of these important schemes,” the paper stated, citing schemes such as the PM Awaas Yojna. To be sure, the paper notes that the Centre has cleverly tilted the scales in its favour by taking more credit for these schemes by adding ‘Pradhan Mantri’ as a prefix for most of them and also increasing funding requirements of the states, which has, in a way, nullified the higher finance commission transfers.
The other driver to not cutting non-finance commission transfers is economic. “A key element of the Union government’s fiscal strategy for growth was to undertake capital expenditure to crowd in private investment. However, the Union government realised that this strategy required implementation through State governments. So, it devised a plan to give interest-free loans to the States for a long period of time. This has emerged as a large component of non–Finance Commission transfers to the States,” the paper argued.
The Rai-Vaishnav paper is a timely and important addition to our understanding of fiscal federalism in India which shows that, on a purely objective basis, the states have not become worse off in terms of their share in Central taxes under the Modi government.
This quantitative fact notwithstanding — the Rai-Vaishnav paper is only concerned with this — one can flag qualitative factors which have and will lead to a weakening of fiscal federalism and, here, the roots go back to the pre-Modi era.
First, an implementation of the Fiscal Responsibility and Budgetary Management (FRBM) Act with the Centre enjoying a soft budget constraint, unlike the states. The Rai-Vaishnav paper actually notes this fact. The FRBM asymmetry has become much worse in the post-GST era, as states have very little autonomy even when it comes to deciding tax rates. This disproportionate squeeze on the fiscal elbow room available to states has a bipartisan consensus in India, and as was pointed out by Niranjan Rajadhyaksha in a 2016 column in Mint, is also symptomatic of India’s regional capital evolving into national capital. Ashok Mitra was among the first (and perhaps the only) person to reckon with in the fiscal federalism ecosystem who rebelled against this consensus.
Secondly, the proliferation of Centrally sponsored schemes is more likely to lead to a rupture in federal solidarity than weaken it in a homogenous manner. This has been a major driver in keeping the share of states in Centre's revenues intact, and is driven more by political considerations of getting the votes of the poor than honouring some constitutional contract between the Centre and the states. One can make the argument that poorer states; most of them located in northern and eastern India, stand to gain more from such transfers than their richer counterparts in the south. Given the different stages of demographic transition in these states, their needs are going to diverge even more in the future. At some point in time, the Republic will have to open up the question of realigning political and fiscal allocation; the former in terms of number of seats in the Parliament and the latter in terms of whether or not the 1971 population shares will be used to decide fiscal awards.
States such as Tamil Nadu are already making noises vis-à-vis this question. Other Opposition-ruled states are, so far, maintaining a tactical silence on these issues. When this contradiction of equity versus justice erupts, fiscal federalism will enter its most difficult phase in India. More than politics, skewed economic growth will be the culprit here. The vexed nature of these issues, perhaps, was a bigger reason why the 15th Finance Commission did not disturb the existing fiscal federalism arrangement than the institutional factors cited in the Rai-Vaishnav paper.
Every Friday, HT’s data and political economy editor, Roshan Kishore, combines his commitment to data and passion for qualitative analysis in a column for HT Premium, Terms of Trade. With a focus on one big number and one big issue, he will go behind the headlines to ask a question and address political economy issues and social puzzles facing contemporary India.
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