15th Finance Commission recommends reduction in States’ share in divisible pool to 41% for FY21

The 15th Finance Commission (FC) has recommended that the States’ share in the divisible pool be pegged at 41 per cent for FY21, a good one percentage point lower than the earlier 42 per cent level suggested by the 14th Finance Commission.

This has been reflected in the FC’s report for 2020-21 tabled in the Lok Sabha by the Finance Minister Nirmala Sitharaman on Saturday. The one percentage point cut has come on account of the re-organisation of the erstwhile State of Jammu & Kashmir.

“We have notionally estimated that the share of the erstwhile State of Jammu & Kashmir would have come to around 0.85 per cent of the divisible pool. We believe there is a strong case for enhancing this to 1 per cent of the divisible pool to meet the security and other special needs of the Union Territories of Jammu & Kashmir and Ladakh,” the report said.

Sitharaman said the government has in substantial measure accepted the recommendations of the FC.

Criteria, weights tweaked

In its report, the FC has tweaked the criteria and weights under which funds are allocated to States. While 15 per cent weight (down from 17.5 per cent) has been assigned to population of a State, the weight for demographic performance has been increased to 12.5 per cent as against 10 per cent allocated by the 14th Finance Commission.

Also, a new criteria of “tax effect" for States has been introduced and assigned 2.5 per cent weightage. The FC has reduced weight for income distance to 45 per cent from 50 per cent.

In a significant decision, the FC has deferred a call on the contentious defence and internal security fund proposed by the Central Government.

“We acknowledge the criticality of the additional Terms of Reference (ToR) asking us to examine whether a separate mechanism for funding defence and internal security is to be set up. There is merit in ensuring a predictable and stable flow of funds for defence and internal security and this will receive appropriate consideration in our final report,” the commission report said.

Interestingly, for 2020-21, the FC has made nominal GDP growth assumption of 11 per cent. On the other hand, the Finance Minister Sitharaman had, in her Budget speech, said that the Government had pegged the nominal GDP growth for 2020-21 at 10 per cent.

Experts’ take

DK Srivastava, Chief Policy Advisor, EY India, told BusinessLine that by assuming nominal GDP growth rate at 10 per cent for FY20 and 11 per cent for FY21, the FC has made “optimistic assumptions”.

According to CSO data, FY20 nominal growth is at 7.8 per cent and the Union Budget has assumed only a 10 per cent growth for FY21.

“These marginally optimistic growth assumptions imply an underestimation of Commission’s recommendation for the revenue gap grants. In determining the vertical devolution, the Commission has effectively reduced the share of States from 42 per cent which was applicable for 29 States to 41 per cent which is applicable to 28 States. This is due to rounding off of Jammu and Kashmir’s share which was 1.854 per cent in a total of 100 per cent, which amounts to close to 0.8 per cent out of 42 per cent. This rounding off works marginally in favour of the Centre,” Srivastava said..

Madan Sabnavis, Chief Economist, CARE Ratings, said the “FC recommendations will be very critical at a time when we are going in for more decentralisation. Higher flow from Union to States is required given that GST has not stabilised and that compensations for revenue loss will increase for the next couple of years too”.

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