The government had recently accepted much of the 15th Finance Commission’s recommendations in its final report, including giving States a 41 per cent share of the divisible pool of taxes and revenue deficit grants of ₹2.95-lakh crore for 17 States over the next five years (2021-22 to 2025-26). BusinessLine interacted with NK Singh, Chairman of the 15th Finance Commission, to discuss the thought process behind those recommendations. Excerpts:

Why did you settle for 41 per cent as the number for deciding States’ share of divisible pool? There were expectations of a higher number than 41 or 42 per cent, given the economy has faced a shock due to Covid-19?

I do not deny there were expectations on the part of States that we would look at a somewhat elevated number. Expectations are more often than not shaped by where you sit. If you sit in a State Capital, it is legitimate for the Chief Minister and Finance Secretary of that State to expect every successive Finance Commission to increase the percentage of allocation from the divisible pool. This expectation is embedded in legacy and past tradition. All States had expected an increase from us.

At the same time, the Union government sought downward adjustment and their expectation was 38-39 per cent, given the stressed fiscal situation of the Centre. We had to make a choice over two competing issues. We had opted for predictability, stability and continuity in retaining it at 41 per cent (after adjustment to Union Territory of J&K). It was a daunting challenge to do so.

The States are complaining that divisible pool is shrinking because of the cess and surcharge issue. Why have you not written an adverse note or red-flagged the cess and surcharge issue in your report?

I encourage you to read paras 3.63, 3.8, 4.25 and 4.26 of our report. You will then come to a conclusion as to whether we have dealt with this or not. We have dealt with this at four places. Instead of writing poetry (red flagging), we have done where the poetry hurts. We have, in the period of our projection, calibrated and frozen in downward direction the net incidence of cess and surcharge.

To give you an idea on how cess and surcharges have grown in recent years – in 2010-11 – the total percentage of cess and surcharge as a percentage of Gross Tax Revenues (GTR) was 10.4 per cent. This increased to 19.9 per cent in 2020-21. It has doubled in 10 years.

So, instead of leaving it at 20 per cent, our calibration of the revenue expenditure permissible for the Central government has been based on 18.4 per cent of cess and surcharge. We have done it in the actual calculus where it really hurts instead of writing poetry.

So, what is the path forward for cess and surcharge? Can the finance commission do anything about it in future awards?

On the path forward... cess and surcharge as a subject are totally outside the mandate of any Finance Commission. All that one can hope is based on more wide-ranging consultations, necessary Constitutional amendment is effected to allow the Finance Commission count some proportion of cess and surcharge as part of divisible pool or have certain amount of proportionality. It would be fair and reasonable, going forward, based on much wider consultation among all stakeholders and States, that necessary amendments are made on the Constitution which enables the coverage of cess and surcharge within divisible pool, either fully or in some part and some proportionality. As Finance Commission, this is not part of our mandate apart from taking adverse note of it which we have. More than adverse note, we have calibrated the likely expenditure by taking a number lower than Budget Estimate (BE).

This means there is no holding back the Centre on cess and surcharge if this suggested Constitutional amendment doesn’t come through?

Technically you are right. After all we (15th Finance Commission) would not be the only one. The poetry written (on Centre’s increased resort to cess and surcharge) by 12th, 13th and 14th Finance Commissions has not made any much virtue.

We have made a beginning in calibrating the permissible expenditure of the Union government and capping the expenditure by a notional figure of cess and surcharge. Short of a Constitutional amendment in coming days, the cess and surcharge issue will continue in the current form.

Anyway, you have to remember that cess and surcharge is not a subject in the domain of the Finance Commission, and it does not emanate from our Terms of Reference. But this subject deserves wider consultation and consensus among stakeholders. The government has to take Parliament on board to bring these changes.

Do you agree with perception in certain quarters that trust deficit between the States and Centre has marred fiscal federalism?

I do not think it will be appropriate to conclude the absence of any trust. It will not be fair to conclude it that way. The Centre has never reneged on its commitment. Both in terms of architecture and the manner in which resources have devolved to the states, there is no absence of federal trust.

The consultative process between the Centre and the States has been exceedingly reasonable. We have through our report reinforced the federal trust.

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