Finance panel casts shadow on Budget

The recommendation of the 14th Finance Commission to raise the share of the States in the central taxes from 32 per cent recommended by the 13th Finance Commission to 42 per cent underlines the need to do some hard thinking.

It will put immense pressure on the Centre, perhaps in the Budget, to resort to surcharges and cesses to make up for the higher devolution burden. The Centre’s fiscal consolidation exercise becomes that much more difficult.

The percentage share of the States in the Centre’s tax revenue, popularly called vertical sharing, should not be left to the caprices of a Finance Commission in the future.

The most important function of a Finance Commission established under Article 280 of the Constitution of India in the year 1950 was to recommend the quantum of vertical sharing of the central taxes in the divisible pool, namely, income tax and union excise duties; it was also to recommend the system of redistribution of the divisible pool among the States, known as horizontal sharing, and recommend grants to States in need of assistance under Article 275 of the Constitution.

The ten Finance Commissions between 1950 and 1992 steadily increased vertical sharing of States in income tax and union excise duties. According to Raja Chelliah, the weight of devolution in the total transfers by Finance Commissions had become a little too high. As a result, enough equalising grants could not be recommended.

When devolution as a percentage of the gross tax revenue of all the central taxes from 1952 to 1993, was computed, it was found the percentage had registered a steep increase from 18.59 per cent in 1978-79 to 28.44 per cent in 1979-80, thanks to the recommendations of the Seventh Finance Commission which, besides increasing the divisible pool of income tax to 85 per cent from 80 per cent, had increased the divisible pool in union excise duties from 20-40 per cent at one stroke.

This percentage, however, had started declining and by 1992-93, devolution as a percentage of the Centre’s gross tax revenue had come down to 24.48 per cent.

This was due to the fact the Centre had started relying on non-sharable taxes like customs and corporate tax for its additional resource mobilisation.

While Chelliah’s preference was to keep 25 per cent of the gross tax revenue receipts as devolution, it is also true that the Centre had not exploited the tax potential available under Articles 268 and 269 of the Constitution, like tax on advertisements in newspapers, as such taxes could only be levied by the Centre but the entire proceeds would go to the States.

In 1982, Ministry of Finance had estimated that the revenues from advertisements in newspapers and periodicals might be in the order of ₹500 crore per annum and the Sarkaria Commission (1984) had recommended amending the Constitution under Article 269 to include advertisements broadcast by radio and television, to facilitate taxes on these advertisements as well.

A preferred option would be tax devolution to the States at 33.33 per cent of the gross tax revenue receipts that would include tax receipts under Articles 268 and 269 of the Constitution.

This has been argued in an article published in the Economic and Political Weekly in March 20-23, 1993, titled ‘Towards an Alternative Tax Sharing in India’.

This model attracted the attention of the Chairman of the Tenth Finance Commission (1992-94) KC Pant.

I had suggested that devolution at 33.33 per cent of the gross tax revenue of the Centre should be incorporated in the Constitution itself and this percentage could be reviewed after a period of 15-20 years through the mechanism of the Finance Commission.

KC Pant, in his report of the Tenth Finance Commission, suggested devolution to the States be fixed at 29 per cent, namely 26 per cent of the gross proceeds of union taxes and duties plus 3 per cent in the gross proceeds of all Central taxes, and that this should remain at this level for a period of fifteen years.

While the Centre accepted this recommendation and amended the Constitution in 1999, to make devolution at 29 per cent of the net proceeds of the tax receipts instead of gross receipts, it left it to the Finance Commission to review the percentage share, instead of freezing it for 15 years as suggested by the Tenth Finance Commission.

Though subjecting vertical sharing of the Centre’s tax revenue beyond 29 per cent every five years was not desirable, the three Finance Commissions that submitted their reports after the Constitutional amendment came into force in 1999 were quite modest in their approach: While the 11th Finance Commission headed by AM Khusro recommended 29.5 per cent, the 12th Finance Commission headed by C Rangarajan recommended 30.5 per cent.

The 13th Finance Commission headed by Vijay Kelkar recommended 32 per cent.

While all these hikes were quite modest, the 14th Finance Commission headed by YV Reddy recommended a 10 percentage point hike from 32 per cent to 42 per cent of the Central taxes, justifying this steep increase on the grounds that cess and surcharge in gross tax revenue of the Centre, which do not form part of the divisible pool, had gone up from 7.53 per cent in 2000-01 to 13.14 per cent in 2013-14

Devolution at 42 per cent of net tax revenue of the Centre will mean an increase 18 per cent from the level of 24 per cent in 1992.

While the Centre has been following the convention of accepting a Finance Commission’s recommendation both with regard to vertical sharing and horizontal redistribution of devolution, it should realise that the 14th Finance Commission has set a bad precedent with regard to vertical sharing. One can expect the successor Commissions to hike the States’ share to 45-50 per cent with utter disregard to the Centre’s fiscal situation, committed liabilities and huge expenditure on defence outlays.

Since the recommendation has already been accepted, the Centre should seriously contemplate bringing a constitutional amendment to freeze devolution at 42 per cent for a period of 20 years so that the future Finance Commissions could only recommend the scheme of horizontal redistribution of devolution among the States.

I would not be surprised if the Union Budget for 2016-17 will have a heavy dosage of cesses and surcharges, as the Centre is left with no other option.

The Report of the 14th Finance Commission is easily the most irresponsible one in the history of Finance Commissions in India.

The writer, a former State Finance Secretary, was Special Secretary (Finance) for the Ninth and Tenth Finance Commissions, for Government of Tamil Nadu

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