Analysis of Fiscal Federalism and the 16th Finance Commission

The editorial titled “Finance Commission strikes a new balance” discusses the implications of the 16th Finance Commission on fiscal federalism in India. While numbers can provide reassurance, they can also obscure deeper issues concerning how power and responsibilities are distributed between the Union and states.

States' Share in the Divisible Pool

• Retention of 41% Share: The decision to maintain the states' share in the divisible pool at 41% is highlighted as a point of continuity.
• Significance of the Pool: The true impact of this percentage depends on the size of the divisible pool.
• Cesses and Surcharges: The Union's increasing reliance on cesses and surcharges, which are not shared with states, diminishes the effective share of states in total Union tax collections.

Impact on State Planning and Borrowing

• States require predictable fiscal rules to effectively plan and manage resources.
• The narrowing of the shareable revenue base limits the comfort provided by maintaining the devolution ratio at 41% and complicates state-level fiscal discipline.

Regional Concerns and Horizontal Share

• Southern States' Share: The increase in the horizontal share for southern states from 15.8% to 17% is acknowledged, yet it is seen as modest when compared to historical shares.
• Equity and Federal Principles: The need for supporting poorer and populous states is acknowledged, but fairness requires acknowledging states' historical contributions in education and public services.

Criteria for Revenue Allocation

• State’s Contribution to GDP: Introduced to recognize state performance but has limited impact due to structural factors.
• Population-related Criteria Dominance: Population-related metrics dominate, limiting the recognition of states' contributions.
• Removal of Tax Effort Criterion: Weakens the link between revenue mobilization and fiscal incentives for states.

The writer, a lawyer and public policy consultant, points out that while the 16th Finance Commission approaches its mandate seriously, the editorial may overstate the achievement of a new fiscal balance. The focus on stability in headline ratios and marginal shifts in shares might not fully address the complexities of fiscal federalism.