States to Get Higher Share of Central Taxes

The Narendra Modi government came good on its pledge to treat the states as partners in long term development in a spirit of cooperative federalism by accepting a key recommendation of the 14th Finance Commission.
The Centre will start transferring a much bigger share of central taxes to states -the 10 percentage point jump to 42% will translate into an additional, estimated Rs.1.78 lakh crore in the next fiscal year.
“We are moving away from rigid centralised planning, forcing a 'one-size fits-all' approach on states,“ Prime Minister Narendra Modi said in a letter to state chief ministers in which he communicated the government's acceptance of the commission's recommendations. “States have always been voicing their opposition to this philosophy for years,“ he said. The changes that have been set in motion should ensure that states will now have greater control over their economic futures besides being able to tailor social welfare programmes to their own particular needs, among other things. The government presented the commission's report in Parliament on Tuesday along with the action-taken report in the first of a series of big-picture financial announcements this week. The Economic Survey for FY 15 will be presented on Thursday , the Railway Budget a day after that and the Budget on February 28.
As per the recommendation of the commission headed by former Reserve Bank of India governor YV Reddy, the total devolution to the states in FY16 will be Rs.5.26 lakh crore against Rs.3.48 lakh crore in FY 15.
The recommendations of the finance commission will have a substantial impact on budget-making for the Centre with a number of departments witnessing big reductions in their allocations.The Centre has decided to discontinue support to eight centrally sponsored schemes, albeit fewer than the commission's recommendation of 30. “This is the largest ever change in percentage of devolution. In the past, when finance commissions have recommended an increase, it has been in the range of 1-2%,“ Finance Minister Arun Jaitley said at a press conference.
However, this is not likely to affect his budget as the total support to states was pegged at 63% of taxes, almost the same as earlier. “The finance commission has subsumed both plan and non-plan expenditure. Moreover, it has not given any sectoral grants, not even for environmental or healthcare. However, this implies that grants for centrally sponsored schemes will have to be curtailed. Else, they will have to raise revenue or cut expenditure,“ said M Govinda Rao, a member of the commission. The acceptance of the recommendations mark at least five major shifts from the past. First, the sizeable increase in tax devolution. Second, taking into account plan revenue expenditures while assessing revenue deficit grants. Third, discontinuing the distinction between special category and other states. Fourth, desisting from awarding sector state specific grants or to subject grants to conditionality. And, fifth, to suggest institutional mechanisms for better monitoring of fiscal rules and to achieve `cooperative federalism'.
The core of this last lies in both increasing the proportion of (virtually much the same) aggregate transfers that will be available as non-debt transfers and to get rid of a swathe of central conditions and restrictions on how to utilise these funds.
This will be a huge help to states in forging their own autonomously generated development scheme and keeping their fiscal deficit in check in the years to come.
“In our assessment, the share of grants and tax devolution to states in the gross revenue receipts has been projected to increase from 47.5% in 2014-15 (base year, as per the previous finance commission formula) to 49.4% in 2019-20,“ the report said.“Thus, the equivalent share as a percentage of divisible pool is set to increase from 61.9% to 63.9%.“ It also made additional provision for revenue deficit states.
To be sure, with these additional receipts in hand, states will see central support to state plans for the revenue part of the expenditure cease. State governments welcomed the higher devolution.“The decision to significantly increase the states' share will enable the states to utilise the enhanced resources according to the felt needs of the residents of the state,“ Haryana chief minister Manohar Lal Khattar said. Compared with the devolution in FY 15, the total outgo to the states in FY 16 will see an increase of more than 45%, Jaitley said. Abhijit Sen, one of the four members of the commission, submitted a dissent note suggesting that devolution to the states should be pegged at 38% in the first year and maintained at that level unless there was an agreement to deal with fiscal problems.The commission suggested a fiscal deficit target of 3.6% for FY 16 and 3% in subsequent years during the award period that runs to FY 20.
By accepting the recommendations of the finance commission, the Centre also has implicitly endorsed the fiscal deficit target of 3.6% of GDP for FY 16 and 3% thereafter. By parting with a larger share of tax revenue, the Centre has to meet a larger share of its own expenditure via non-tax receipts including borrowings.However, it can significantly reduce the borrowing it currently undertakes to lend to states.
The commission has recommended creating a fund for compensating states for any loss arising from transition to the goods and services tax, suggesting that such compensation be made available for five years --100% of shortfall in the first three, 75% and 50% in the remaining two, respectively. GST is scheduled to be rolled out on April 1, 2016. The finance commission has made some grants to states to be passed on to panchayats and municipal bodies. It has made recommendations on how to collect funds for disaster management.