33

Thirteenth Finance Commission: An Overview

R. Shyama Nair

33.1 Introduction

The Constitution of India provides for the formation of a Finance Commission (FC) every five years under Article 280, to recommend to the President of India certain measures, relating to the division of the financial resources between the centre and the states. The Thirteenth Finance Commission (13th FC) was constituted in November 2007, under the chairmanship of Dr Vijay Kelkar, to make recommendations on the specified aspects of the centre state fiscal relations for the period 2010–15. The Commission submitted its report to the President on 30th December 2009.

The major constitutionally mandated responsibilities of a FC are the (i) distribution between the union and the states of the net proceeds of shareable central taxes, (ii) determining the grants—in-aid to the states which are in need of assistance and (iii) recommending measures to augment the consolidated fund of a state to supplement the resources of the local bodies. These are mentioned as such in the Presidential Order constituting a FC. In addition to these substantive functions, any other matter can be referred to a FC in the interest of sound finance under Article 280 (3) (d) of the Constitution. It has become customary to mention certain considerations in the Presidential Order, appointing a Commission, which the Commission may consider, among others, while making its recommendations. The Presidential Order listing out the main functions, additional matters and considerations constitutes the Terms of Reference (ToR) of a FC.

33.2 Terms of Reference of the 13th FC

1. ‘The Commission shall make recommendations as to the following matters, namely:
   1. The distribution between the union and the states, of the net proceeds of taxes which are to be, or may be, divided between them under Chapter I Part XII of the Constitution, and the allocation between the states of the respective shares of such proceeds.
   2. The principles which should govern the grants-in-aid of the revenues of the states, out of the consolidated fund of India, and the sums to be paid to the states which are in need of assistance by way of grants-in-aid of their revenues under article 275 of the Constitution for purposes other than those specified in the provisos to clause (1) of that article.
   3. The measures needed to augment the consolidated fund of a state, to supplement the resources of the panchayats and municipalities in the state on the basis of the recommendations made by the FC of the state.
2. The Commission shall review the state of the finances of the union and the states, keeping in view, in particular, the operation of the States’ Debt Consolidation and Relief Facility 2005–10 introduced by the central government, on the basis of the recommendations of the Twelfth FC, and suggest measures for maintaining a stable and sustainable fiscal environment, consistent with equitable growth.
3. In making its recommendations, the Commission shall have regard, among other considerations, to:
   1. The resources of the central government, for five years commencing on 1 April 2010, on the basis of the levels of taxation and non-tax revenues, likely to be reached at the end of 2008–09.
   2. The demands on the resources of the central government, in particular, on account of the projected gross budgetary support to the central and state plan, the expenditure on civil administration, defence, internal and border security, debt-servicing and other committed expenditure and liabilities.
   3. The resources of the state governments, for the five years commencing on 1 April 2010, on the basis of the levels of taxation and non-tax revenues, likely to be reached at the end of 2008–09.
   4. The objective of not only balancing the receipts and expenditure on revenue account of all the states and the union, but also generating surpluses for capital investment.
   5. The taxation efforts of the central government, and each state government and the potential for additional resource mobilization to improve the tax-Gross Domestic Product (GDP) ratio in the case of the union and states.
   6. The impact of the proposed implementation of goods and services tax with effect from 1 April 2010, including its impact on the country’s foreign trade.
   7. The need to improve the quality of public expenditure, to obtain better outputs and outcomes.
   8. The need to manage ecology, environment and climate change, consistent with sustainable development.
   9. The expenditure on the non-salary component of maintenance, and the upkeep of the capital assets and the non-wage related maintenance expenditure on the plan schemes, to be completed by 31 March 2010 and the norms on the basis of which specific amounts are recommended for the maintenance of the capital assets, and the manner of monitoring such expenditure.
   10. The need for ensuring the commercial viability of the irrigation projects, power projects, departmental undertakings and public sector enterprises, through various means, including a levy of the user charges, and the adoption of the measures to promote efficiency.
4. In making its recommendations on various matters, the Commission shall take the base of population figures as of 1971, in all such cases where population is a factor for determination of the devolution of taxes and duties, and the grants-in-aid.
5. The Commission may review the present arrangements as regards financing of disaster management, with reference to the National Calamity Contingency Fund and the Calamity Relief Fund, and the funds envisaged in the Disaster Management Act, 2005 (53 of 2005), and make appropriate recommendations thereon.
6. The Commission shall indicate the basis, on which it has arrived at its findings, and make available the estimates of the receipts and expenditure of the union and each of the states.
7. The Commission shall make its report available by the 31st day of October 2009, covering the period of five years commencing on the 1st day of April 2010 (page 12–13 of the 13th FC Report).

It may be noted here that many issues have been raised with regard to the terms of reference of the 13th FC. Some experts are of the view that though many of the guidelines given in the ToR are important, they should not by themselves be the primary objective of the Commission. The focus should be on the fair transfer of resources between the centre and the states as the FC is supposed to be an impartial body (M.G. Rao, 2008). To some others, the terms of reference, reflect a bias in favour of the centre. The demand of the states that the terms of reference be drawn up jointly, by both the centre and the states, through consultation and ratification by the Inter State Council, is relevant in this context since the FC has to maintain the constitutional position of equivalence and neutrality between the central government and the states (Centre for Budget and Governance Accountability).

33.3 Recommendations of the 13th FC

The 13th FC submitted its report to the President of India in December 2009. The major recommendations of the Commission are discussed in the following sections.

33.3.1 Sharing of Union Taxes

The Commission has recommended that the share of states in the net proceeds of the union taxes may be fixed at 32 per cent. The Commission has also recommended on the inter-se distribution of the states’ share amongst the states. An indicative ceiling of 39.5 per cent of the gross tax revenues of the centre has been fixed for the total transfers to the states on the revenue account. With a view to reducing their share in its gross tax revenue, the centre to review the levy of surcharges and cesses.

33.3.2 Goods and Services Tax (GST)

The Commission has recommended a model Goods and Service Tax (GST) structure, through the implementation of a Grand Bargain to provide incentives to the states to agree to the model. The structure includes features such as single rate, zero rating of exports, inclusion of various indirect taxes at the centre and state level, major rationalization of the exemption structure, etc. The Commission recommends a grant of Rs 50,000 crore, to meet the compensation claims of the state governments for revenue losses on account of the implementation of the GST between 2010–11 and 2014–15. The unspent balances will be distributed amongst the states in the terminal year of the award period, as per the devolution formula. The amount will not be disbursed, if the states do not reach a consensus on implementing the GST. The main features of the model are:

• It should not distinguish between goods and services. It should be levied at a single positive rate, on all the goods and services. Exports should be zero rated. The tax compliance costs should be low, and the tax credits should be available across all the tax jurisdictions.
• Taxes to be subsumed in the central GST are the central excise duty and additional excise duties, service tax, additional customs duty (countervailing duty) and all the surcharges and cesses.
• The state GST portion would subsume the value added tax, central sales tax, entry tax, whether in lieu of the octroi or other wise, luxury tax, taxes on lottery, betting and gambling, entertainment tax, purchase tax, state excise duties, stamp duty, taxes on vehicles, tax on goods and passengers, taxes and duties on electricity, and all the state surcharges and cesses.
• Special provisions for certain goods such as petroleum. Exemptions would be allowed only on the basis of a common list applicable to all states and the centre which should comprise only of unprocessed food items, public services provided by all the governments, excluding the railways, communications and public sector enterprises, the service transactions between the employer and the employee, and the health and education services.
• Though there will be multiple statutes, one for the central GST and one for the state GST, efforts should be made to maintain the basic features of the law uniform, to the maximum extent possible.

33.3.3 State Finances

• The practice of diverting the plan assistance to meet the non-plan needs of the special category states should be discontinued.
• All states need to draw a roadmap for the closure of the non-working PSUs by March 2011. The divestment and privatization of the PSUs should be considered and actively pursued.
• With reference to the power sector, transmission and distribution losses to be reduced. Systems to be put in place, to avoid delays in the completion of hydro projects.
• Migration to the new pension scheme needs to be completed at the earliest.
• Large cash balances to be utilized before resorting to the fresh borrowings.
• Government of India to ensure uniformity, in the budgetary classification code across all the states.
• Public expenditure through creation of funds, outside the consolidated fund of the states to be discouraged.
• State finance accounts to include comprehensive data on all the subsidies, and information on the number of employees at each level, and details of the maintenance expenditure.

33.4 Roadmap for Fiscal Consolidation

• To eliminate revenue deficit of the centre by 2014–15.
• A target of 68 per cent of GDP for the combined debt of the centre and states should be achieved by 2014–15.
• The Medium Term Fiscal Plan (MTFP), to be made a statement of commitment rather than a statement of intent.
• The detailed breakup of the grants to the states under the overall category of the nonplan and plan grants, to be disclosed in the central budget/MTFP. Statement on the tax expenditure to be made clear. Compliance costs of major tax proposals to be reported. Revenue consequences of the capital expenditure to be projected in MTFP. Fiscal impact of the major policy changes to be incorporated.
• Transfer of disinvestment receipts to the public account to be discontinued, and all disinvestment receipts to be maintained in the consolidated fund.
• The FRBM Act needs to specify the nature of shocks that would require a relaxation of the FRBM targets. Given the exceptional circumstances of 2008–09 and 2009–10, the fiscal consolidation process of the states was disrupted. It is expected that the states would be able to get back to their fiscal correction path by 2011–12, allowing for a year of adjustment in 2010–11. States that attained zero revenue deficit in 2007–08, to eliminate the revenue deficit by 2011–12, and to achieve a fiscal deficit of 3 per cent of the Gross State Domestic Product (GSDP) by 2011–12 and maintain it thereafter.
• States to amend the Fiscal Responsibility and Budget Management Acts (FRBM) to build in the fiscal reform path worked out.
• State specific grants, recommended to be released upon compliance.
• Borrowing limits for the states to be worked out by the Ministry of Finance using fiscal reform path, thus acting as an enforcement mechanism for the fiscal correction by states.
• Loans to states from the National Small Savings Fund (NSSF) contracted till 2006–07, and outstanding at the end of 2009–10 to be reset, at 9 per cent rate of interest, subject to conditions.
• The National Small Savings Scheme to be reformed into a market-aligned scheme.
• Loans from GOI to states and administered by ministries/departments other than the MoF, outstanding as at the end of 2009–10 to be written off.
• For the states that have not availed the benefit of consolidation under the Debt Consolidation and Relief Facility (DCRF), the facility, limited to the consolidation and interest rate reduction, should be extended, subject to the enactment of the FRBM Act.

33.4.1 Local Bodies

• The Commission has recommended a basic grant and a performance grant for the local bodies. Both these grants in any year have been quantified, based on a percentage of the divisible pool of the preceding year.
• The performance grants are to be released if the states meet conditions specified by the Commission.
• The total grant recommended for the local bodies aggregates to Rs 87,519 crore over the award period. The Commission has also recommended the distribution of the grants, between the urban and rural areas, and the inter-se distribution between states.
• The state governments should appropriately strengthen their local fund audit departments, through capacity building as well as personnel augmentation.
• To buttress the accounting system, the finance accounts should include a separate statement, indicating head-wise details of the actual expenditures, under the same heads as used in the budget for both the Panchayati Raj Institutions (PRIs) and the Urban Local Bodies (ULBs). The Commission recommends that these changes be brought into effect from 31 March 2012.
• The state governments should ensure that the recommendations of the State Finance Commissions (SFCs) are implemented without delay and that the Action Taken Report (ATR) is promptly placed before the legislature.
• The development plans for the civilian areas within the cantonment areas (excluding areas under the active control of the forces), should be brought before the district planning committees.
• The state governments should lay down guidelines for the constitution of nagar panchayats.

33.4.2 Disaster Relief

The National Calamity Contingency Fund (NCCF) should be merged into the National Disaster Response Fund (NDRF), and the Calamity Relief Fund (CRF) into the State Disaster Response Funds (SDRFs), of the respective states. The contribution to the SDRFs should be shared between the centre and the states in the ratio of 75:25 for the general category states and 90:10 for special category states

• An assistance of Rs 250 crore to be given to the National Disaster Response Force, to maintain an inventory of items required for immediate relief.
• Provisions relating to the District Disaster Response Fund (DDRF) in the Disaster Management (DM) Act may be reviewed, and setting up of these funds left to the discretion of the individual states.
• Accounting norms to be followed for the continuance of central assistance to SDRFs.

33.4.3 Grants-in—Aid to States

• Non-plan revenue deficit and performance incentive: Non plan revenue grant of Rs 51,800 crore is recommended for eight states, and the performance grant of Rs 1,500 crore is recommended for three special category states, who have graduated from a non-plan revenue deficit situation.
• Elementary education: A grant of Rs 24,068 crore is recommended for elementary education over the award period. The education grant will be in addition, to the normal expenditure of the states for elementary education.
• Environment: An amount of Rs 5,000 crore is recommended as forest grant for the award period. Twenty five per cent of the grants in the last three years are for the preservation of the forest wealth. An incentive grant of Rs 5,000 crore is recommended for developing the grid-connected renewable energy based on the states’ achievement in the renewable energy capacity addition from 1 April 2010 to 31 March 2014. An amount of Rs 5,000 crore is recommended as the water sector management grant for four years.
• Improving outcomes: States should be incentivized to enroll their residents, who participate in the welfare schemes within the Unique Identification (UID) programme. A grant of Rs 2,989 crore is proposed to be given to the state governments in this regard. A grant of Rs 5,000 crore is proposed to support improvement in a number of facets in the administration of justice. A grant of Rs 20 crores is recommended for the promotion of innovation by setting up a Centre for Innovation in Public Systems (CIPS) to identify, document and promote innovations, in the public services across the states. To enhance the quality of statistical systems, a grant of Rs 616 crore is recommended. A grant of Rs 10 crore will be provided to each general and special category state, to set up an employees’ and pensioners’ data base.
• Maintenance of roads and bridges: An amount of Rs 19,930 crore is recommended as grant for the maintenance of roads and bridges for four years of the award period. The maintenance grant will be in addition to the normal expenditure, incurred by the states.
• State specific needs: A total grant of Rs 27,945 crore is recommended for the state specific needs. Accounts shall be maintained and utilization certificates, statements of expenditure to be provided as per the general finance rules.

33.4.4 Debt Relief to States

• The Commission has recommended two debt relief measures to be extended to all states. Firstly, it has recommended that the interest rates on loans from the National Small Savings Fund (NSSF) to states contracted till the end of 2006–07, and outstanding as at the end of 2009–10, be reset at interest rate of 9%.
• The second debt relief recommended by the Commission is write-off of the central loans to the states that are administered by the central ministries, other than the Ministry of Finance outstanding as at the end of 2009–10.
• The Commission has also recommended extension of the debt consolidation facility, recommended by the Twelfth FC (12th FC) to the states that have not yet availed this benefit.
• All these measures would be available to the states, only if they amend/legislate FRBM Acts in accordance with the recommendations of the Commission.

33.5 Review of the Recommendations of the 13th FC in Comparison with the 12th FC

It is well known that the core tasks of a FC relate to sharing of the central taxes with the states, and the central grants to the states. But what is observed over the past few years is that there has been an expansion in the terms of reference of the FCs, to go beyond tax devolution and grants. The present Commission is also no exception to this.

33.5.1 Tax Devolution

Both the 12th FC and the 13th FC have tried to address the issues of vertical and horizontal distribution of tax revenues of the centre. While the 12th FC recommended the share of the states in the net central taxes at 30.5 per cent, the 13th FC recommended that the states’ share in the central taxes be increased by 1.5 per cent to 32 per cent. There has only been a marginal increase in the share, though the states in a joint memorandum submitted to the 13th FC, had requested to enhance the share of the states to 50 per cent.

Table 33.1 gives the different criteria and the relative weights adopted by the 12th FC and the 13th FC.

It can be seen from the table that the variables adopted by both the Commissions are the same, except that the criterion of tax effort was dropped by the 13th FC. The weights assigned by the two Commissions to some of these variables differ. It is observed that the weights assigned to the population and area are the same with both the Commissions, while that of the fiscal distance and fiscal discipline differ. The fiscal distance was given a weightage of 50 per cent under the 12th FC, but it was brought down to 47.5 per cent under the 13th FC. Similarly fiscal discipline was assigned a weight of 7.5 per cent by the 12th FC, while it is 17.5 per cent under the 13th FC.

TABLE 33.1 Criteria and Relative Weights for Determining inter se Shares of States Under Twelfth and Thirteenth Finance Commissions

Therefore, while the distribution neutral factors like population and area were given the same weights as that of the 12 th FC, the redistributive factor like the fiscal capacity distance and the fiscal incentive factor like fiscal discipline were given different weights under the 13th FC awards. These are the major changes brought out by the 13th FC in the tax devolution criteria.

Table 33.2 gives the percentage share of each state under the 12th FC and 13th FC awards. Column 4 shows the difference between the shares assigned by the two Commissions. It is evident from Column 4 that the shares of the ten general category states have declined during the 13 th FC, when compared with that of the 12th FC.

33.5.2 Grants-in-Aid

The total grant provided by the 13th FC is Rs 3,18,581 crore against Rs 1,42,640 crore provided by the 12th FC. The 13th FC has not set aside any amount for the health sector, unlike the 12th FC which had earmarked Rs 5,887crores. Similarly, the amount given for education is only for elementary education in the 13th FC, while 12th FC had provided for education as a whole. The Non-plan Revenue Deficit (NPRD) grant is earmarked only to eight of the special category states on the assumption that other states would have a surplus on the revenue account during 2010–11 to 2014–15, which is really doubtful going by the deficit indicators of the states during 2009–10 published in the RBI reports.

A comparison of grants-in-aid of both the commissions is given in Table 33.3. The 13th FC has recommended a performance grant of Rs 1,500 crore for the three special category states (Uttarkhand, Assam and Sikkim), who have graduated from a NPRD situation, as an incentive for them to continue on their path of fiscal prudence. The 13 th FC has earmarked Rs 14,446 crore towards improving the outcomes, which include grants for reduction in the infant mortality rates, improvement in the supply of justice, incentive for issuing the UIDs, the district innovation fund and grants for the employee and pension database. A grant of Rs 50,000 crores is set aside by way of special grants to meet the compensation claims of the states during the implementation of GST. However, the Commission also makes it clear that this amount will not be disbursed in the event of the states deviating from the model GST suggested by the Commission. The Commission rather than giving more autonomy to the states, has ended up giving tied grants to the states, to achieve objectives in the areas that are the functional responsibility of the states (EPW 27 Mar 2010 editorial).

TABLE 33.2 Shares of States as per 12th FC and 13th FC Awards

TABLE 33.3 Grants-in-Aid Made to States as per the Recommendations of the 12th FC and 13th FC (Rupees in Crore)

33.5.3 Fiscal Consolidation

The 12th FC had recommended a plan for restructuring the public finances, by which the fiscal deficit to GDP ratio of the centre and states is fixed at 3% of the GDP and the revenue deficit relative to the GDP for the centre and the states be brought down to zero by 2008–09. The states had to enact the fiscal responsibility legislation for achieving these targets. The enactment of the Fiscal Responsibility legislation (FRL) was made mandatory to avail the debt relief, and debt write off schemes. All the states, except West Bengal and Sikkim have gone in for the FRL. The enactment of the fiscal responsibility legislation by almost all the states following the recommendation of the 12th FC resulted in the rule-based management of the public finances replacing the discretionary management of the public finances which had resulted in all round deterioration in public finances. This is a major landmark in the history of public finances in the country. (fincomindia.nic.in). The 13th FC has tried to carry these thoughts forward.

For the fiscal responsibility legislation to be more effective, the 13th FC recommends that the central government revises its medium term fiscal policy statement, with a more detailed and elaborate medium term fiscal plan, which incorporates three year forward estimates of the revenue and expenditure, with the detailed break up and an explanation of how these estimates have been generated. The 13th FC expects the government to use such a medium term fiscal plan as an operational policy document, to enhance the credibility of the FRBM legislation. Towards this end, the Commission recommends the proper reporting of plan and non plan grants to states, reporting of contingent liabilities, statements on the compliance costs of tax proposals. The Commission also recommends that all the disinvestment receipts be maintained in the consolidated fund.

The main objective of the road map to fiscal consolidation is to take account of the fiscal situation of the centre and the state governments, and to set macro fiscal targets, with reference to the overall position. To achieve this, the macroeconomic parameters identified, are the fiscal deficit and the combined debt—GDP ratio.

The 13th FC expects the states to get back to their fiscal correction path by 2011–12, taking into account 2010–11 as an adjustment year to overcome the global recessionary trends of 2008–09 and 2009–10. But as per the RBI reports (See State Finances, 2009–10), the knock-on effect of the global financial crisis, and the consequent slowdown in the economic activity has impacted the finances of the states. Out of the 28 states, ten states are likely to turn from the revenue surplus to revenue deficit states during 2009–10 (BE), while 22 states have budgeted a gross fiscal deficit/gross state domestic product ratio, of above 3 per cent. This deterioration in the ratio is attributed to the sluggishness in the revenue side, as well as a significant rise in the expenditure, particularly on account of the committed expenditure. These incipient signs of slippage, evident in the state finances on the revenue and expenditure, could halt the process of fiscal consolidation. The RBI thus observes that this slippage needs to be arrested quickly, through a swift designing of a fiscal correction path.

The Commission has set a target of combined debt-GSDP ratio at 68 per cent, with 45 per cent for the centre, and 25 per cent for the states, as against a combined debt-GSDP ratio target of 75 per cent by the 12th FC. The reduction in this ratio as foreseen by the 13th FC, is to be achieved by allowing the central government to take the responsibility of all the borrowings, for any unanticipated shocks in future.

The road map for fiscal consolidation prescribed by the Commission has to be monitored by the fiscal council. But apprehensions are prevalent among the academic scholars, about the capacity of the council in undertaking the independent review and monitoring of the process. The fiscal discipline cannot be ensured without the governments willingness, and legislation on the fiscal discipline will not help unless the government is ready to bite the bullet according to M. G. Rao.

33.5.4 Goods and Services Tax

One of the important issues that the 13th FC has been asked to look into, is the impact of the GST. The Task Force on the goods and services tax had submitted a report to the Government of India in which a model GST frame work was given. The recommendations of the 13th FC on the GST have been mainly based on the ‘flawless GST’ as envisaged in the Task Force Report. The grand bargain has been worked out, in which all the states will concurrently tax all the goods and services in a dual mode. But the tax rates suggested by the Commission, 5% for the central GST and 7% for the state GST are too low, which would result in a huge loss of revenue for the states. The conditionalities imposed on the states for claiming the compensation for revenue loss, consequent to the implementation of the GST may not be welcome to the states. It impinges on the autonomy of the states, in matters where they have constitutionally assigned powers of taxation. (D. K. Srivastava) The states have made it clear, that they want a higher combined rate with a low rate for the essential commodities, and a larger exemption list. These differences have to be thrashed out before the components of reforms are brought in. According to M. G. Rao ‘the report of the Thirteenth FC, rather than accelerating, has actually reversed the process, and it will take some time before the threads are picked up again stipulating a corner solution has led the states to adopt a defiant posture’.

33.6 Other Recommendations

The recommendation of the Commission, regarding the revenues arising from fiscal commons like profit petroleum, profit gas and spectrum, is commendable. The Commission is of the view that these non-tax revenues of the centre be made shareable between the centre and the states, by bringing them under the divisible pool through constitutional amendment. Similarly, the Commission has recognized the emergence of rural and urban local bodies as key players in bringing out development transformation. The Commission suggests constitutional changes, for allowing third tier to access the resources directly from the divisible pool. The 13th FC, for the first time, has been asked to take into account the gross budgetary support to the central and state plans as a demand on the resources of the centre.

33.7 Conclusion

On the whole, it appears that the 13th FC has tried to fulfill its mandate, by working within the various limitations that the FC are exposed to. The institution of FC will continue to deal with the emerging challenges and the new environment. The FC, especially the recent ones, have played a major role in improving the fiscal situation of the centre and the states, by laying emphasis on the fiscal restructuring. It is expected that the fiscal consolidation will be back on the track after the temporary fall out in the fiscal correction path, witnessed during the recessionary period of 2008–09. Fiscal federalism and the FCs will always be a work in progress.

Reference

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