Editorial. The 16th Finance panel has its work cut out

The terms of reference of the 16^th Finance Commission, whose formula for sharing of revenues between the Centre and States will come into effect for five years after 2026, were announced recently. The Commission, as always, is expected to draw up its report in two years. While the TOR does not point to any major departure from the norm, the southern States, as in the past, are expected to oppose the existing formula for horizontal devolution. They are opposed to the weightage given to the inverse of per capita income (45 per cent) and population (15 per cent) in the current formula, laid down by the 15^th finance panel.

The argument that such a weightage does not reward the performance of the southern States with respect to raising income and reducing population is not entirely convincing. There’s an irony here — sharing on the basis of inverse from per capita income is justified precisely because the southern States have surged ahead of the northern ones in the post-reforms period, widening regional inequalities. These gaps cannot be disregarded. There is also a broader economic logic at work. The southern States have benefited from the cheap supply of labour from the rest of the country to develop their economies. However, the question is whether there could be incentives built into the sharing formula to acknowledge performance, while retaining the basic character of redistribution from the haves to the have-nots, which is non-negotiable.

The 15^th Finance panel horizontal sharing formula, in force till 2026, cannot essentially be faulted. The new Commission can build on it. The controversy around pegging population to the 2011 Census, a shift made by the 15th finance panel, is overdone. The 1971 Census is too dated to address the resource concerns of the poorer, populous regions. Besides, even as population accounts for a weightage of 15 per cent in the criteria for devolution, a weightage of 12.5 per cent has been accorded for demographic performance — southern States do benefit here. A weight of 2.5 per cent for ‘tax and fiscal efforts’ in force now, can be raised to reward good fiscal management. A similar index can perhaps be introduced to reward social sector outcomes, akin to ‘demographic performance’. While the devolution rightly revolves around ‘income distance from highest per capita income’ or inverse of per capita incomes (reduced from 50 per cent in the 14^th panel to 45 per cent at present), a 5 percentage point cut can be considered to balance equity and performance.

There is little basis to the argument that GST, as a destination-based tax, hurts producer States. Most producer States are high consuming States as well. Besides, GST is meant to incentivise production by being a consumption tax. As for vertical devolution, the current share of 41 per cent is unlikely to change in a big way. It is hoped that political discord does not come in the way of arriving at a sharing formula that works for all.

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