#1 Winners and Losers: How the 14th Finance Commission Recommendations Impacted State Revenues
By Avani Kapur, 08 Aug 2016

In February 2015, the Union Government accepted the recommendations of the 14th Finance Commission (FFC) and set the stage for a radical overhaul of India’s fiscal architecture. The recommendations were designed to enhance the fiscal autonomy of states by increasing the proportion of funds transferred to states from the divisible pool[1] of taxes from 32% to 42%. Other major changes included: a change in the formula for determining inter-state tax shares and a decrease in state-specific Finance Commission (FC) grants from those with conditionalities towards more untied block grants for certain areas.

The acceptance of the FFC had two major consequences. On the one hand, it led to the Ministry of Finance (MoF) allocating Rs 5.06 lakh crore as tax devolution in the FY 2015-16 (Revised Estimate (RE)), significantly higher than the Rs. 3.38 lakh crore in FY 2014-15 Actuals.[2] On the other, it led to a decrease in the funding through Centrally Sponsored Schemes (CSSs) - the Union Government’s primary vehicle for financing social sector investments in the country. Specifically, Budget 2015 saw a discontinuation of some CSSs, reduction in allocations for others and the change in the fund-sharing ratios for CSSs putting greater onus on state governments. These changes led many to believe that the increase in tax devolution was offset by cuts in CSSs. For instance, the state of Andhra Pradesh noted,

The reduction of the Central share for key schemes such as SSA, National Health Mission, ICDS etc, will have adverse effect on the State development indicators.”[3]

It is important to note that this was a period of transition leading to a significant amount of chaos and confusion. Many state governments had passed their budgets prior to the announcement of acceptance of FFC recommendations in February 2015. Their budgets thus, did not reflect the changed union assistance. The changed fund sharing ratios of CSSs was also announced only in October 2015.

In order to shed some light into the implications of these changes on state budgets, my colleagues and I set out to collect state budget data for 19 states. A complete analysis of the impact of the FFC would require Actuals for FY 2014-15 and FY 2015-16. However, Actuals have a two-year lag period and are thus currently available only for FY 2014-15. We have thus used REs for FY 2015-16 as the most realistic current estimate of government expenditure.

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So have states received more resources from the Union post the FFC?

The answer is Yes. All the 19 states studied received at least 20% more funds from the Union government in FY 2015-16 RE compared to FY 2014-15 Actuals. There is however some state variation in the quantum of increases. Haryana, Telangana, Himachal Pradesh, Jharkhand and Chhattisgarh received the highest increase at over 60%. In contrast, Tamil Nadu and Punjab received less than 25% more from the Union.

But a simple analysis of increases in Union receipt does not tell us a complete picture. For one, 2014 was a year of expenditure contraction across all sectors. Consequently, less money was received by states in FY 2014-15 Actuals compared to Budget Estimates (BE) for FY 2014-15. Moreover, accurate estimates of CSS funds received and spent by states are not available in real time. Traditionally, we have seen that states receive a significantly lower proportion of approved allocations. For instance, in FY 2014-15 of the total Rs. 56,529 crore approved for Sarva Shiksha Abhiyan (SSA), only 62% was released[1].

Moreover, whilst the FFC had recommended a shift in the composition of expenditure from tied scheme based funding to more untied block grants, states show a mixed picture. Through much of FY 2015-16, the Union Government introduced a number of supplementary budgets that significantly enhanced the overall pool of CSS monies available to state governments in key schemes. In aggregate, CSSs and similar schemes categorized as Central Assistance to State Plans increased by over Rs. 11,000 crore between the BEs and REs. As a result, the share of tied funding increased in some states. For instance, in Tamil Nadu, share of tied funds in total union transfers increased from 40% in FY 2014-15 Actuals to 47% in FY 2015-16 RE. Haryana too saw a 13 percentage point increase.

What does this mean going forward for state autonomy? 

First, the increase in fund sharing ratios for states may mean a further decrease in untied funding as states will be expected to put a greater share of their resources for CSSs. Moreover, the acceptance of the 7th Pay Commission could further impact state revenues.

However, there is some positive news. On the 3rd of August 2016, the Cabinet approved the recommendations of the Chief Ministers Report on Restructuring CSSs which argued for states to have flexibility in choosing between different activities within a CSS according to their own priorities. This would at least give states some flexibility to prioritise their limited resources.

It will be interesting to track how states respond to these changes and how they will utilise the increased tax devolution from the Union. We will continue tracking this – so do watch this space. The next blog in this series will focus more on impact on CSSs in FY 2015-16.

 

[1] RTI filed by Accountability Initiative

[1]  The divisible pool can be thought of as the sum of all Union taxes and duties, excluding collection costs, surcharges, and specific-purpose cesses. For a more precise definition see Arts. 268 through 271 of the Constitution of India

[2]  Ministry of Finance (2016). Union Budget. Budget at a Glance, “Resources Transferred to State and U.T. Governments”. Accessed on 6 May 2016.

[3] NITI Aayog (2015). Report of the Sub-Group of Chief Ministers on Rationalisation of Centrally Sponsored Schemes. October 2015. Accessed on 25 May 2016