Conclave of Finance Ministers of Southern States CM’s Inaugural Address

At the outset, I would like to extend a warm welcome to all the distinguished participants of this one day workshop. I need not have to explain the importance of the theme that we have chosen to deliberate upon in this workshop.
The workshop is convened to have a detailed review and critique of the terms of reference of the Fifteenth Finance Commission of India. As you are aware, the terms of reference of the previous Finance Commissions have also been subjected to detailed scrutiny by all the concerened. The work of the Finance Commission attracts much attention in the country because of the vital constitutional responsibility entrusted upon it.

But the heat of the discussion that followed the appointment of the Fifteenth Finance Commission is unprecedented because of the conspicuous bias in-built in the terms of reference of the new commission. It is widely feared that the terms of reference framed by the Central Government would prevent the Finance Commission from fulfilling its constitutional responsibility. As many of you would agree, the Finance Commission should be guided more by the constitutional mandate than by the arbitrarily spelt out terms of reference.

Therefore, it is only proper for all of us to appeal to the Union Government to reframe the terms of reference of the Fifteenth Finance Commission in such a way that, the Commission can adhere to and uphold its constitutional mandate. This reframing of the terms of reference is imperative, to strengthen the federal structure of the country on one hand, and to reinforce the unity and integrity of the nation on the other.

Like in other major federations, the Indian system also is characterised by the huge and worsening gap between the distribution of power to mobilise resources on the one hand and to spend on development and welfare responsibilities on the other. This is exactly the reason why most federations have in-built arrangements for the devolution of resources.
The Constitution of India is quite exemplary in this respect. Our Constitution provides for the appointment of the Finance Commission every five years to recommend sharing of resources so that the fiscal space of the constituents, especially the states, are well protected.

The role of Finance Commission assumes special significance in India, given the fact that the Centre is given near monopoly over the right to mobilise resources. This bias in the distribution of fiscal power is all the more glaring since the introduction of Goods and Service Tax (GST) in the country. GST meant further erosion of fiscal autonomy of the states.

We are all aware that the terms of reference of the Fifteenth Finance Commission have created apprehension about principles of fairness and equity in the distribution of national resources for development. Expecting that your discussions will go into the details of the terms of reference, I shall deal with some general matters of principle.
First, Article 1 of the Constitution of India recognises India as a Union of States. The unity of India can be preserved only if there is real fairness and equity in the matter of devolution of powers and resources to the States by the Union Government. The foremost objective of the Finance Commission is an equitable distribution of financial resources between the two units of the Union.

Even a cursory glance at the State List at the Seventh Schedule of the Constitution shows that in the allocation of duties between the Centre and the States, fundamental tasks of enhancing human development, income growth, livelihoods, and protecting and sustaining the environment, are entrusted to the States. However, although these major tasks of nation-building are the duty of the States, the resources to finance those tasks are controlled by the Centre.
I emphasise this point: The States in India today neither have the resources to fulfil their tasks as laid down in the Constitution, nor do they have the right to raise such resources. The present situation is not because of the action of the States, but is directly the consequence of the policies pursued by the Union Government.

There is thus a great asymmetry in India’s federal system. The Centre’s capacity to mobilise resources is far greater than that of the States, but the latter are required to undertake development expenditures that exceed their revenue generating capabilities. The Constitution of India entrusts the Finance Commission with the responsibility of addressing this anomaly. So the basic mandate of the Finance Commission should be seen as that of deciding an appropriate quantum of unconditional devolution of resources from the Centre to the States, combined with more specific grants.

The devolution of resources by the Fifteenth Finance Commission assumes further significance in the current environment, in which the finances of States have received a double blow in form of demonetisation and the Goods and Services Tax (GST). As the report of the Committee on the impact of demonetisation on Kerala’s economy appointed by the State Planning Board pointed out, purchasing power and economic activity in the State, particularly in the traditional sectors and in the co-operative banking sectors, were severely affected by demonetisation.

The freedom of States to raise resources has further been restricted by the introduction of GST. It was further restricted by the equal division of GST despite the recommendations of the Chief Economic Adviser that States be allocated a higher share. The GST has taken away the right of the States to design their own special initiatives in resource mobilisation. They now have hardly any major tax left with them to make a difference to State resources.
Therefore, with respect to the devolution of resources, we are of the view that vertical devolution should not be brought down from 42 percent awarded by the Fourteenth Finance Commission and accepted by the Union Government. In fact, because of the introduction of GST and the equal division of GST, States have lost much of the space for manoeuvring. In this context, raising the share of divisible pool from 42 percent may be considered.

Secondly, we are concerned by the decision to use the population data of 2011 as the base for tax devolution. For the devolution of funds, 1971 population rate was considered as the criterion. Now it is given a go by. If it happens so, the states like us will lose heavily. The states should not be penalised for having successfully reduced their rate of population growth. In fact, States that have achieved demographic and health indicators must not be denied the opportunity to reap the dividends from demographic change.

These States have incurred huge fiscal costs in order to achieve a lower population growth and healthy demographic indicators. They have made substantial investments – revenue and capital – on education, health and directly on family welfare programmes. These States need to further continue their investments in these areas to sustain the demographic achievements. Bringing down the rate of growth of population does not mean less expenditure for States. On the contrary, it creates new commitments by the States to those in the labour force and to senior citizens.

Many States of India have achieved a replacement rate of growth of population or have gone below that rate in a short span of time. An immediate effect of this is a sharp rise in the proportion of elderly in the population. The care of the elderly is the responsibility of State Governments. The enhanced costs of such care must be considered by the Commission in making its awards and in deciding the population criterion to be used.

Thirdly, the current terms of reference go far beyond the constitutional mandate of the Finance Commission. Indeed, they intensify efforts to use the Finance Commission as an instrument of fiscal consolidation and to impose the ideological and economic agenda of the Central Government on States. It is not the task of a Finance Commission to recommend ‘roadmaps for fiscal management’ or to impose its perception of what policies are good for the people of the States. That is for the democratically elected State Governments to decide.

Fourthly, this blatant interventionism finds further and dangerous expression in a statement that should not find a place in any list of terms of reference, that is: “the Commission may also examine whether revenue deficit grants be provided at all.” As a senior economist has written, “to suggest that revenue deficit grants may not be provided is tantamount to asking the Commission to ignore Articles 275 and 280-3(b) of the Constitution.”
Examining the need to provide revenue deficit grants is a retrograde step and will adversely affect the already constrained State finances. It would result in restricting capital and development spending.

We are of the opinion that revenue deficits are offshoots of the path of development followed by States and cannot be brought down in the short term. For instance, Kerala’s human development achievements are built on our investments in the people, in social sectors, health and education in particular. Public expenditure on them is a large part of the government spending and it has not been easy to bring down revenue deficits despite higher tax efforts. To discontinue post-tax devolution of revenue deficit grants would go against the principle of co-operative federalism.

Fifthly, the terms of reference explicitly privileges the “committed expenditures” of the Centre. We should request the Commission to affirm its constitutional status and responsibility by upholding federalism and fiscal autonomy of the States. The Finance Commission should not take a “residual approach” to the question of vertical devolution. The approach should not be that of distributing what is left over after providing for the requirements of the Centre. The Finance Commission has the constitutional mandate and responsibility to ensure that the States are given enough fiscal room for fulfilling their constitutionally assigned responsibilities. The terms of reference put forward by the Centre should not be a hindrance in the Finance Commission discharging its constitutional duty.

Sixthly, the terms of reference are unprecedented in asking the Fifteenth Finance Commission to consider proposing performance-based incentives beyond those relating to fiscal responsibility, population, and devolution to local bodies. This reflects the viewpoint and ideological inclinations of the Central government and are attempts to micro-manage the fiscal domain of the State governments.

Let us not forget that, in many spheres of activity, States have set the agenda for development. These sectors include health, education, forest management, the public distribution of food, agricultural production – the list goes on. Such development was not because the concerned States received Central incentives. Best practices were created on their own initiative.
Thus, for the Finance Commission to propose “measurable performance-based-incentives” is nothing short of an attack on the federal structure mandated by the Constitution. Such terms of reference, we fear, might end up altering the status of the Finance Commission from that of a constitutional authority entrusted with the job of devolving the fiscal resources of the nation, to that of an administrative mechanism designed to perform the duty of fiscal administration and monitoring.

I would like to reiterate that the federal spirit of the constitution should be borne in mind when we address any question relating to the devolution of funds at any time. This workshop should be of great use in enlightening both the finance commission and the union government on a wide range of aspects that affect the prospects of the states.
I welcome you once again to Kerala and this workshop, and look forward eagerly to the results of your deliberations. I hope you will have a nice time here.

Thank you…