The Hindu Business Line : Fiscal federalism: Making `Paul' States

At the core of fiscal federalism is the rob-Peter-to-pay-Paul approach. It punishes productivity, diligence and thrift. It rewards shirking and indifference. No wealth can be created through such an iniquitous policy. India has too few Peter States that are wealthy enough to be robbed. The remaining that are a little productive will choose to become poor instead of being robbed, says G. Ramachandran.

FISCAL FEDERALISM is an unattractive and unsustainable economic approach to building India's economic robustness. It has as much a chance of survival as a snowflake in a volcano. It is as powerless as an earthworm is in drilling a hole in hard rock.

Here is the reason. Fiscal federalism involves the transfer of hard-earned prosperity from States that are productive, diligent and thrifty to those that are not. It also involves the transfer of wealth from some poor States to other poorer ones.

The core of fiscal federalism is made up of the rob-Peter-to-pay-Paul approach to wealth creation. It punishes productivity, diligence and thrift. It rewards shirking and indifference. No wealth can be created through such an iniquitous policy. Therefore, all States will be made poorer.

India has too few Peter States that are wealthy enough to be robbed. The remaining that are a little productive now will choose to become poor instead of being robbed. They will willingly become the Paul States.

The absence of constitutional disincentives aimed at discouraging shirking and indifference is a serious shortcoming. In such circumstances, it makes good social and economic sense to put in place incentives aimed at encouraging diligence and thrift. The Twelfth Finance Commission has acted diligently while specifying its principal policy recommendations. It includes numerous incentives aimed at promoting diligence, thrift and good governance.

Hackneyed and incorrect

Professors C. P. Chandrasekhar and Jayati Ghosh (Macroscan, Business Line, June 7) are apprehensive that the principal policy recommendations of the Twelfth Finance Commission signal the death of fiscal federalism. Their apprehension is most likely based on the assumption that the people of those States with a reputation for being poor bear the brunt of indebtedness and interest payouts.

The list of States that have a reputation for being poor typically include Bihar, Chhattisgarh, Jharkhand, Madhya Pradesh and Uttar Pradesh. However, the flaw in the assumption is that they may have restricted their analysis to the aggregate debt of each State while ignoring the relative indebtedness per million people in each of the States.

The Table on relative indebtedness and purchasing power growth shows that the five States with a `tradition' of being poor have the lowest relative indebtedness per million people. These States are home to about 35 per cent of India's population.

Their average relative indebtedness per million people is about 0.06. By contrast, India's average relative indebtedness per million people is about 0.097. The average Indian bears a burden that is about two-thirds more than that borne by the five States.

Beast of burden

People of Goa bear the most. Its Chief Minster would be pained to know that the people of Goa bear three-and-a-half times as much burden as the average Indian does. Goa's relative indebtedness per million people is 0.335. This is five-and-a-half times the burden borne by the people of Bihar, Chhattisgarh, Jharkhand, Madhya Pradesh and Uttar Pradesh.

Goa's relative indebtedness is high because it has to borrow more per capita than the other States. It may borrow more for two reasons. First, it makes more useful investments in its social and economic infrastructure than other States.

Second, it does not receive as large a share per capita of the tax revenues as other States. Second reason is wholly a quirky outcome of the formula for allocating tax and other revenues pooled by the Centre.

Goa's high relative indebtedness may appear justifiable if its capability to produce incomes is regarded as the basis for allocating pooled revenues.

Goa grew its per capita purchasing power by Rs 8,917 between 1999 and 2003. By contrast, the five States that have the least relative indebtedness grew their per capita purchasing power by an average of Rs 3,720. Goa is perhaps an easy and `just' source for wealth transfer. Its people deserve to be treated as beasts of burden. They are productive; they can be milked at will.

Breaking spines

The current formula for allocating pooled revenues punishes Goa for its capability to grow its per capita purchasing power. If that is appalling and unacceptable, steel yourself for this. The formula for allocating pooled revenues breaks the spine of at least eight States.

The people of Sikkim, Nagaland, Arunachal Pradesh, Tripura, West Bengal, Manipur, Orissa and Andhra Pradesh are unjustly treated as beasts of burden. Their relative indebtedness is about 0.15, and higher than India's average of 0.097. What is disturbing is that the eight States grew their per capita purchasing power by merely Rs 5,580.

By compressing their share of pooled revenues, India's fiscal federalism has made at least States bigger borrowers than they should be. What this means is that their future capability to invest in their social and economic future has been comprehensively undermined.

Race to the bottom

Goa is too small a State to facilitate a big transfer of wealth to the States with privilege. Sikkim, Nagaland, Arunachal Pradesh, Tripura, West Bengal, Manipur, Orissa and Andhra Pradesh are home to almost 20 per cent of India's population. But their capability to take care of themselves has been undermined. Their capacity to take care of others has been brutally broken. So, we have to look elsewhere to facilitate big transfers of wealth.

Exit Punjab, Jammu and Kashmir, Haryana, Kerala, Gujarat, Maharashtra and Tamil Nadu. Exit has been consciously preferred to `enter'. These seven States have an average relative indebtedness of over 0.14. They account for about 29 per cent of India's population. They have been very productive. They grew their per capita purchasing power by over Rs 11,200. They are fat targets for fiscal milking.

Enter behavioural economics. Enter rational economics. The people and the leaders of these seven States would be careful not to be as productive, diligent and thrifty as they have been hitherto. If they outperform themselves, their share of pooled revenues will fall. No one likes being the target for fiscal milking. They would take care to suppress growth. Feeding at the trough will be a better choice. And, everyone would be worse off if everyone chooses to suppress growth and feed at the trough.

(The author is a financial analyst. Feedback may be sent to indiagrow@yahoo.com and pari@thehindu.co.in)

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