15th-finance-commission-holds-meeting-with-its-advisory-council-summary

Context: Recently, the Fifteenth Finance Commission (FFC) had online meetings with its Advisory Council and discussed various issues confronting the Commission now. 

More about the news:

  • The meeting, chaired by Shri N. K. Singh, Chairman FFC was attended by all members and senior officials of the Commission. 
  • These were the second round of meetings with the Advisory Council, after the submission of the Report of the FFC for the year 2020-21. 

Observations made by the council:

  • The Members of the Advisory Council felt that the impact of the Covid pandemic and the national lockdown on the Indian economy can come through 
    • the slowdown in the domestic activity, 
    • its impact on the cash flows of financial institutions and business enterprises and 
    • the loss of global demand for Indian products because of a steep global recession. 
  • All of them were unanimous to suggest that the projections of real GDP growth need to be relooked into entirely, and revised downwards considerably. 
  • Once the lockdown of the economy is released, the recovery can only be expected to be gradual, depending on the ability of 
    • the workforce to get back to work soon, 
    • restoration of supplies of intermediates and cash flows and,  
    • the demand for output. 
  • Therefore, the full magnitude of the economic impact of Covid will only be clear only over a course of time. 

Need of the hour:

  • Governments will have a  substantial expenditure burden on account of health, support to poor and other economic agents. 
  • The Council Members felt that the shortfall in tax and other revenues will be large due to subdued economic activity. Hence, fiscal response to the crisis should be much more nuanced. 
  • It is important not just to look at the size of fiscal response but also carefully at its design. 
  • The Council apprised the Finance Commission of the following different suggestions floating around in terms of public expenditure support to the economy:
  1. Small scale enterprises: As their activity levels and cash flows are affected, it is important that a support mechanism be devised to help them overcome this problem. 
  2. Non-banking financial companies: In order to avoid bankruptcies and deepening of NPAs in the financial sector, measures should be appropriately designed. 
    1. Measures like partial loan guarantee may help. 
    2. The Reserve Bank of India will have a key role in ensuring that financial institutions are well-capitalized
  3. The finances of the Central and State Governments need to be watched carefully. 
    1. As of now, adequate provision for ways and means advances can largely help governments to manage cash-flow mismatches. 
    2. As we move ahead, we need to think of options for financing the additional deficit. 
    3. It is important to ensure that the State governments get access to adequate funds to undertake their fight against the pandemic. 
  4. The Council also felt that it is likely that different States may come out of the severity of the impact of the pandemic in different stages. 
    1. Hence, the revival of activity in different States will be at a varied pace.

The Fifteenth Finance Commission along with its Advisory Council is keenly watching the evolving situation globally as well as domestically.

About Finance Commission:

  • The Finance Commission is a Constitutionally mandated body that is at the centre of fiscal federalism. 
  • Article 280 of the Constitution of India provides for a Finance Commission as a quasi- judicial body, which is to be constituted  by the president of India  every 5 years (or at such earlier time as he considers necessary) to recommend the distribution of net proceeds of taxes between Centre and states, and among states.
  • The core responsibility of FC is 
    • to evaluate the state of finances of the Union and State Governments, 
    • recommend the sharing of taxes between them, 
    • lay down the principles determining the distribution of these taxes among States. 
  • Its working is characterised by extensive and intensive consultations with all levels of governments, thus strengthening the principle of cooperative federalism
  • Its recommendations are also geared towards improving the quality of public spending and promoting fiscal stability. 
  • On the whole the Finance Commission faces new challenges in the process of the evolution of our federal polity. 
  • As an important Constitutional entity, the Commission is committed to balancing competing claims and priorities among all three tiers of government in a credible manner.

15th Finance Commission:

  • The first Finance Commission was set up in 1951 and there have been fifteen so far. Each of them has faced its own unique set of challenges.
  • The Fifteenth Finance Commission was constituted on 27 November 2017, under the chairman NK Singh, against the backdrop of 
    • the abolition of Planning Commission (as also of the distinction between Plan and non-Plan expenditure) and 
    • the introduction of the goods and services tax (GST), which has fundamentally redefined federal fiscal relations.
  • New dynamic: The reorganisation of the State of Jammu and Kashmir into two Union Territories - one of Jammu and Kashmir and one of Ladakh - presents a new dynamic. 
  • Formula that decides a State’s share

Weight in 15th FC

Parameters

Weight in 14th FC

15

 (2011 Census)

Population

27.5

(17.5 - 1972, 10 - 2011 Census)

15

Area

15

10

Forest and Ecology

7.5

45

Income Distance

50

12.5

Demographic Performance

-

2.5

Tax Effort

-

 

Income distance: 

  • Income distance is the distance of the state’s income from the state with the highest income.  
  • The income of a state has been computed as average per capita GSDP during the three-year period between 2015-16 and 2017-18.  
  • States with lower per capita income would be given a higher share to maintain equity among states.

Demographic performance:  

  • The Demographic Performance criterion has been introduced to reward efforts made by states in controlling their population.     
  • States with a lower fertility ratio will be scored higher on this criterion.  

Forest and ecology: This criterion has been arrived at by calculating the share of dense forest of each state in the aggregate dense forest of all the states.

Tax effort: This criterion has been used to reward states with higher tax collection efficiency.   

The Term of Reference of 15th FC:

The Terms of Reference of the current Commission have some distinctive features, including 

  • The demand on the resources of the Central Government particularly on account of defence, internal security, infrastructure, railways, climate change, commitments towards administration of UTs without legislature,etc. 
  • The demand on the resources of the State Governments, particularly on account of financing socioeconomic development and critical infrastructure, assets maintenance expenditure, balanced regional development etc.
  • The impact on the fiscal situation of the Union Government of substantially enhanced tax devolution to States following recommendations of the 14th Finance Commission, coupled with the continuing imperative of the national development programme including New India – 2022.
  • The impact of the GST, including payment of compensation for possible loss of revenues for 5 years, and abolition of a number of cesses, earmarking thereof for compensation and other structural reforms programme, on the finances of Centre and States. 
  • Recommending monitorable performance criteria for important national flagship programmes such as
    • Efforts made by the States in expansion and deepening of tax net under GST
    • Efforts and Progress made in moving towards replacement rate of population growth, etc.
  • Examining the possibility of setting up permanent non lapsable funding for India’s defence needs. 

Key concerns regarding ToR to the 15th FC

  1. Use of 2011 census: Considering the use of the 2011 census as the basis for resources allocation between states is the most serious issue.
    1. This is because switching to the 2011 census would disadvantage states that performed better in controlling their population over the decades.
    2. Hence, it is seemingly apparent that the states that have progressed faster, in terms of their socio-economic status are being penalised for their successes in developmental initiatives.
    3. Particularly, funds for southern states might get stifled as their family planning initiatives have almost stabilised their populations.  
  2. Inter-state tensions: This is creating inter-state tensions, which is adding to the already existing cultural tensions between the northern and southern states.
     

Key Recommendations of 15th FC:

15th FC was to submit its report for the period 2020-2025. However, its term was extended to 2020-26. 

Hence, apart from the present interim report(2020-21), it will submit its second report for 2021-22 to 2025-26 in October.

  • Devolution of taxes to states: The share of states in the centre’s taxes is recommended to be decreased from 42% during the 2015-20 period to 41% for 2020-21.  
    • Reason for decrease: To provide for the newly formed union territories of Jammu and Kashmir, and Ladakh from the resources of the central government.
  • Grants-in-aid: In 2020-21, the following grants will be provided to states: 
    • revenue deficit grants, 
    • grants to local bodies, and 
    • disaster management grants.  

The Commission has also proposed a framework for sector-specific and performance-based grants.  State-specific grants will be provided in the final report.

  • Recommendations on fiscal roadmap
    • Fiscal deficit and debt levels:  It recommended that both central and state governments should focus on debt consolidation and comply with the fiscal deficit and debt levels as per their respective Fiscal Responsibility and Budget Management (FRBM) Acts.
    • Off-budget borrowings: It recommended that both the central and state governments should make full disclosure of extra-budgetary borrowings as the financing capital expenditure through off-budget borrowings detracts from compliance with the FRBM Act.
    • Statutory framework for public financial management: The Commission recommended forming an expert group to draft legislation to provide for a statutory framework for a sound public financial management system.  
    • Tax capacity: The Commission recommended: (i) broadening the tax base, (ii) streamlining tax rates, (iii) and increasing capacity and expertise of tax administration in all tiers of the government. 
      • In 2018-19, the tax revenue of state governments and central government together stood at around 17.5% of GDP, which is far below the estimated tax capacity of the country.  
      • Further, India’s tax capacity has largely remained unchanged since the early 1990s.   
    • GST implementation: The Commission highlighted some challenges with the implementation of the Goods and Services Tax (GST).  These include: 
      • large shortfall in collections as compared to original forecast, 
      • high volatility in collections, 
      • accumulation of large integrated GST credit, 
      • glitches in invoice and input tax matching, and 
      • delay in refunds.  

The Commission observed that the continuing dependence of states on compensation from the central government (21 states out of 29 states in 2018-19) for making up for the shortfall in revenue is a concern.  

It suggested that the structural implications of GST for low consumption states need to be considered.

 

Advisory council of 15th FC

  • The commission constituted an advisory council to advise it on matters related to its terms of reference. 
  • The council consisted of the president of Forum for Strategic Initiatives and former Chief Economic Adviser to the Government of India.
  • Chief Economic Adviser to the Government of India, Krishnamurthy Subramanian, was inducted as a member of the advisory council in May 2019.