The 15th Finance Commission, which the government notified on November 27, 2017, will have to first contend with the slowdown in the Indian economy. There is an upward trend in the fiscal deficits of states.
The inter-governmental transfer system has become overly complex with different sharing arrangements for different taxes; the spending autonomy of the states, combined with their ability to borrow, has obstructed efforts at consolidating public finances; there is little incentive for states to improve revenue performances and revenue-sharing arrangements have led to pro-cyclical policies at the state level.
The high levels of inter-governmental transfers necessitate that states ensure that provincial tax enforcement and structural reforms are strengthened. The problem with persistent off-budget spending has proved a drag on the fiscal deficits of the states. The vertical balances to the states relative to the Centre’s gross revenue receipts have shown trend increases in every Finance Commission and it would not be possible to reduce the devolution without a corresponding increase in fiscal and revenue deficits of the states. The higher devolution under the 14th Finance Commission have seen marginal increases in social sector allocations. There are pressures to increase allocations to centrally sponsored schemes (CSS) for higher expenditure on health and education. The tax buoyancies have been affected by the transition to the GST and the GST compensation to states will continue till 2022. For the 15th Finance Commission, GST will usher in higher tax buoyancy by bringing in a large number of new tax payers into the net. Higher tax collections under GST will provide the Centre room for fiscal manoeuvre to finance the inter-governmental transfer system.
On horizontal balances, the 15th Finance Commission has the responsibility of equalising the widening gap between richer states and the low-income states. These inequalities have resulted in widely differing social and capital expenditure between the states. A large part of the equalisation effort by the Commission will have to be through grants-in-aid rather than devolution. The 14th Finance Commission’s recommendations ushered in a new era of fiscal federalism in India. Devolution to the states significantly went up from 32% to 42%. While most countries have found it difficult to finance federal transfers of about 30% to the provinces, India has taken it to 42%. The government followed up the historic devolution with the constitution of the NITI Aayog to promote cooperative federalism and enacted a constitutional amendment to establish the GST Council. These major progressive steps were backed by restructuring the CSS allocation ratio from 75:25 to 50:50 to provide greater flexibility and ownership to the states. In turn, the states were mandated to pursue the objectives of zero revenue deficit, fiscal deficit not exceeding 3% of GSDP, interest payments-to-revenue receipt ratio not exceeding 10% and debt-to-GSDP ratio not exceeding 25%. Despite these historic steps, there remain challenges. The resource requirements of the power sector remain very high. In some states, the fiscal deficit with power sector allocations have climbed to around 9%. The deteriorating public debt dynamics caused by the requirements of the power sector’s restructuring will be a major area of concern for the 15th Finance Commission. An alternate fiscal scenario will need to be considered to limit the on-budget fiscal deficits to 3% by including the power sector.