Fiscal federalism GS: 2 "EMPOWER IAS"

In news:

• Faultlines in the Centre-State fiscal relations have widened due to Covid. States are not getting what they should as per the 14th Finance Commission report.

 

Centre-state tussle

• The tussle for the rights of States has been focused on Article 356.
• Partial behaviour by the Governors, regional party governments were politically destabilised.
• Little was done to implement the report of  Justice R.S. Sarkaria Commission on Centre-State relations.
• The new faultline in the Centre-State relation could be over the way report of 14th Finance Commission is being implemented.
• This began well before COVID-19, but the pandemic and its economic disruption have brought things to an edge.

 

Issues over the implementation of 14th Finance Commission report

• The 14th Finance Commission report in 2015 promised devolution of more finances to the States.
• As part of the process, States would have new responsibilities, especially in the social sector.
• The Goods and Services Tax (GST) regime was also justified as a grand bargain that would eventually leave all States better off.
• In reality, tax devolution to States has been consistently below 14th Finance Commission projections.
• One reason for this has been the economic slowdown, and lower-than-expected GST collections.
• The shortfall in GST collection for 2018-2019 was 22% when compared to projections.
• Payments to the States have been delayed as well.
• There is a ₹6.84 lakh crore gap between what the 14th Finance Commission promised to States and what they have received.
• States undertook programmes and projects spending 46% more than the Central Government; today the figure is 64%.
• Despite spending less than the states the Centre’s fiscal deficit exceeds the consolidated State deficit by 14%.

 

FRBM Act

• The FRBM is an act of the parliament that set targets for the Government of India to establish financial discipline, improve the management of public funds, strengthen fiscal prudence and reduce its fiscal deficits.
• It was first introduced in the parliament of India in the year 2000 by Vajpayee Government for providing legal backing to the fiscal discipline to be institutionalized in the country.
• Subsequently, the FRBM Act was passed in the year 2003.

 

NK Singh Committee:

• A committee was set up under NK Singh in 2016 to review the act.
• The committee on its part recommended that the government should target a fiscal deficit that is 3 percent of the GDP by 2020 and bring it down to 2.5 percent by 2023.

 

Features of the FRBM Act

• It was mandated by the act that the following must be placed along with the Budget documents annually in the Parliament:

1. Macroeconomic Framework Statement
2. Medium Term Fiscal Policy Statement and
3. Fiscal Policy Strategy Statement

 

Fiscal Indicators

It was proposed that the four fiscal indicators be projected in the medium-term fiscal policy statement viz.

1. Revenue deficit as a percentage of GDP,
2. Fiscal deficit as a percentage of GDP,
3. Tax revenue as a percentage of GDP and
4. Total outstanding liabilities as a percentage of GDP

 

What is the significance of an FRBM Act?

• The popular understanding of the FRBM Act is that it is meant to “compress” or restrict government expenditure. But that is a flawed understanding.
• The truth is that FRBM Act is not an expenditure compressing mechanism, rather an expenditure switching one.
• In other words, the FRBM Act – by limiting the total fiscal deficit (to 3% of nominal GDP) and asking for revenue deficit to be eliminated altogether – is helping the governments to switch their expenditure from revenue to capital.
• This also means that – again, contrary to popular understanding – adhering to the FRBM Act should not reduce India’s GDP, rather increase it.

 

Need to revisit the FRBM provisions:

• Due to pandemic, the fiscal deficit for States, collectively, is inevitably going to breach the projection of 2.04%.
• As per provisions of the Fiscal Responsibility and Budget Management (FRBM) Act, the GSDP can actually accommodate a fiscal deficit of 3%.
• Now, post-pandemic, this limit will be crossed.
• The FRBM has an “escape clause” that allows for a one-time relaxation of the fiscal deficit threshold upto 0.5% in a time of exigency.
• The escape clause has been utilised by the Centre but it has proven woefully insufficient in addressing the current crisis.
• Fiscal policymakers and technocrats agree that the rigidity of the FRBM has to be revisited.
• It should allow for greater flexibility and consultation as to when and how the “escape clause” can be applied.
• The Centre has gone in for subjective interpretation, imposing conditions that are outside the scope of the FRBM.

 

Additional Information: What is the Finance Commission? The Finance Commission is constituted by the President under article 280 of the Constitution, mainly to give its recommendations on distribution of tax revenues between the Union and the States and amongst the States themselves. Two distinctive features of the Commission’s work involve redressing the vertical imbalances between the taxation powers and expenditure responsibilities of the centre and the States respectively and equalization of all public services across the States.   What are the functions of the Finance Commission? It is the duty of the Commission to make recommendations to the President as to: the distribution between the Union and the States of the net proceeds of taxes which are to be, or may be, divided between them and the allocation between the States of the respective shares of such proceeds; the principles which should govern the grants-in-aid of the revenues of the States out of the Consolidated Fund of India; 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 Finance Commission of the State; any other matter referred to the Commission by the President in the interests of sound finance. The Commission determines its procedure and have such powers in the performance of their functions as Parliament may by law confer on them.   Who appoints the Finance Commission and what are the qualifications for Members? The Finance Commission is appointed by the President under Article 280 of the Constitution.   As per the provisions contained in the Finance Commission [Miscellaneous Provisions] Act, 1951 and The Finance Commission (Salaries & Allowances) Rules, 1951, the Chairman of the Commission is selected from among persons who have had experience in public affairs, and the four other members are selected from among persons who: are, or have been, or are qualified to be appointed as Judges of a High Court; or have special knowledge of the finances and accounts of Government; or have had wide experience in financial matters and in administration; or have special knowledge of economics