Opinion

Regional inequalities and resource transfers

R Gopalan |MC Singhi | Updated on: Jun 21, 2022
Transfers of finances to States on the principle of equity may lead to the problem of moral hazard

Transfers of finances to States on the principle of equity may lead to the problem of moral hazard | Photo Credit: Denis Vostrikov

Post-reform India has seen widening inter-State inequalities, despite equity-oriented Central transfers

State governments are largely responsible for the development of backward areas. However, allocation of resources from the Centre has been an important instrument in this process.

While India has lower spatial income disparities than countries such as Brazil, China and Indonesia, these disparities have actually grown in the post-reforms period. Spatial disparities and the presence of backward areas even within and across States have been a unique feature of India.

One can mention the contiguous corridor in the deprived areas of Andhra Pradesh, Odisha, Chhattisgarh, Jharkhand and Bihar. Income disparities are matched, even exceeded, by disparities in non-income indicators. Sharply rising disparities have coincided with economic reforms and opening up of the Indian economy. The widening income differentials between more developed and relatively poorer States is a matter of serious concern.

The SDG indicators notwithstanding, the per capita income is the most important surrogate measure of convergence and equality across States as it determines both the accessibility and affordability of services. Overall per capita income of the States averaged ₹5,920 in 1991-92, immediately after the economic reforms.

Rising incomes

Average income increased gradually to reach ₹18,118 in 2001-02, a decade later, and further to ₹68,845 in 2011-12 and ₹1,74,024 in 2021-22. Per capita income doubled every six years or so, growing annually at 11.9 per cent, in the last 30 years of the post-reform period.

Though the overall growth was reasonably strong, inter-State inequality not only continued to persist but widened further. The coefficient of variation of per capita income of States increased from 37 per cent in 1991-92 to 76 per cent in 2011-12 before slightly moderating to 67 per cent in 2021-22.

The ratio of per capita income of a State from the average continued to show similar pattern over the 30-year period, with Sikkim and Goa leading the pack of States with a ratio exceeding 3, indicating that the average per capita income of these States was more than three times the average income of all the States put together. There is a remarkable consistency in the ranking of States in terms of per capita income, at top, middle and bottom levels.

BIMARU tag

Decline in the rank of Punjab, at number 2 in 1991-92 with per capita income nearly double the national average to almost on average in 2021-22, has indeed been astonishing and surprising. It has one of the lowest CAGR of 9.9 per cent during the 30-year period. Bihar, Jharkhand, Madhya Pradesh, Chhattisgarh, Uttar Pradesh and Rajasthan continue to be at the bottom, indicating that the tag ‘BIMARU’ is yet to be shaken off by them.

It is not that the problem has not been recognised. Both in terms of transfer of resources and facilitation for infrastructure and industrial development, concerns of the backward States have been considered proactively. Institutional transfers by way of Finance Commission and by the erstwhile Planning Commission have been based on both equity and efficiency.

Relative importance attached to each of these parameters has differed across successive Commissions (see graphic), but nearly half of the total tax transfers were based on equity consideration with the efficiency parameters being given only a token recognition.

The transfers from erstwhile Planning Commission based on the Gadgil-Mukherjee formulae had also allocated higher weightage to backwardness. Loan grant component in discretionary transfers, or project specific transfers also have a bias in favour of certain category of States.

Overall transfers to States from the Union government increased from ₹30,923 crore in 1991-92 to ₹14,96,035 crore in 2021-22 (BE) recording an annual growth of 13.8 per cent. Per capita transfers have increased from ₹369 in 1991-92 to ₹1,122 in 2021-22, recording an annual growth of 12.1 per cent, a shade lower adjusting for the growth of population.

Inter-State distribution of these transfers has been highly skewed and biased in favour of geographically smaller States and economically weaker States.

Contrary to per capita GSDP, the skewness has shown a moderating trend as the coefficient of variation of transfers of resources from the Centre has declined from 418 per cent in 1991-92 to 230 per cent in 2021-22.

Three factors seem to have contributed for this skewness.

First, the introduction of area as a distinct factor in inter-se allocation with a minimum weight of 2 per cent to each State benefiting smaller States with a smaller geographic area at the cost of bigger States; second, the doing away with the Special category status to North-East States which saw a sharp decline in their relative share in 2021-22 compared to 1991-92 and; third, because of a decline in weights assigned to poverty or income distance and some weightage being assigned to demographic changes and tax effort/fiscal discipline.

Notwithstanding slight modifications in the criteria, Haryana, Maharashtra, Tamil Nadu, Karnataka and Gujarat have continued to have per capita transfers nearly half of the national average.

There has been a decline in relative share of North-Eastern States as a group with average annual rate of growth transfers in some cases even falling below 10 per cent as against an average CAGR of 12.05 per cent.

Rate of growth of most of the other States nearly converged with the exception of Punjab, which witnessed a near doubling of relative share and an annual growth of 14.8 per cent.

Moral hazard

Despite high weights being assigned to poverty or related component, the relative share of poorer States like Uttar Pradesh, Bihar, Odisha, Rajasthan and others remained sticky with narrow movements on either side.

The transfers to an extent are bearing out what the Thirteenth Finance Commission had mentioned —that the excessive use of equity consideration may create a risk of moral hazard in making States lax in improving revenue efforts and managing their finances prudently and therefore the ‘principle of efficiency’ which addresses this issue should not be ignored.

Moreover, horizontal distribution making these transfers equalising may also not be fair to the middle and high income States as they contribute far more to the Central taxes.

(To be concluded)

Gopalan is a former Finance Secretary, and Singhi is a former Senior Economic Adviser, Ministry of Finance

Published on June 21, 2022
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