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(Ashwin Vardarajan is a third year student at Symbiosis Law School, Pune.) Every government authority, public body and institution requires finances to survive, which is an in-expellable element for its day-to-day functioning. India’s federal structure, laid down under the Constitution of India (“Constitution”) burdens the Central government to distribute funds to the States after it has been duly accounted and collected in the form of taxes, levies, tariffs etc. The 15th Finance Commission Report (“FCR”), in its interim report on the distribution of financial resources between the Centre and States for the fiscal year 2020-21, has raised important questions on how financial resources are distributed under India’s Constitutional framework. The Constitutional Framework The Centre and States collect revenue in the forms of taxes, toll fees, exercise etc., and they all go into the pockets of the Centre or the State on basis of who collects the revenue. For example, if the Central government imposes certain taxes on persons living in a State, the revenue collected thereof shall be considered as Central revenue. This distribution of powers to collect revenue stems from the broader classification of powers of legislative competence provided under Schedule VII of the Constitution. Part XII of the Constitution lays down how Central revenues, after collection, are to be distributed between the Centre and the States in a fiscal year. The method and quantity of distribution of financial resources between the Centre and the States, and between States, is decided by the Finance Commission (“FC”) constituted by the President of India under Article 280 of the Constitution. The revenue collected by the Centre are distributed amongst the States, and form part of the consolidated funds of the States which they thereafter utilise. FCRs play a pivotal role in determining how the devolution of such revenue from the Centre to the States takes place.
FCRs are made on the basis of the terms of reference (“TOR”) which have been made to the FC by the President under Article 280(3) of the Constitution. Articles 280(3)(a)-(c) lay down a list of items which the FC is bound to make recommendations on; namely those relating to: the division of net proceedings from taxes, the grants-in-aid in the states’ revenue out of the Consolidated Fund of India and measures needed to augment the consolidated funds of states to supplement financial resources to panchayats and municipalities. Further, Article 280(3)(d) states that the FC may make recommendations on anything else which the President seeks recommendations on under the TOR. Thus, the FC may step out of the boundary prescribed under Articles 280(3)(a)-(c) only if the TOR allows it to via Article 280(3)(d). Once the FCR has been circulated, the President under Article 281 is bound “to cause every recommendation made by the Finance Commission together with an explanatory memorandum as to the action taken thereon to be laid before each House of Parliament”. Here, it is pertinent to note that FCR recommendations are not binding on the Central government, and nothing in Article 280 mandates them to consult States before formulating the TOR. The 15th FCR’s Predicament This brings us to the concerns surrounding the 15th FCR. The TOR made to the FC were a little different this time around – when compared to the TORs made to previous FCs. The latest TOR stated that the FCR recommendations relating to the demographic performance of State and consequent distribution of funds must be based on the 2011 population census, as opposed to the 1971 census used by previous FCs. The 15th FCR noted that certain (south) Indian States felt that they would be receiving lesser devolution of funds from the centre if the 2011 census is followed (¶3.28). In order to dampen this dissatisfaction, the FC, quite creatively, adopted a new rubric of the total fertility rate (“TFR”) in order to determine the States’ demographic performance(which signifies the age, gender and income of the people within the population), which was “computed by using the reciprocal of TFR of each State, scaled by the population data of Census 1971”. However, south Indian States were still given a lesser share of devolution due to their poor demographic performance. For instance, Bihar received more tax devolution in comparison to Kerala. This issue flows from clause 4 of the TOR – which directed the FC to distribute more taxes collections to those States which perform better on the demographic performance rubrics. Although States should be incentivised and consequently encouraged to collect taxes in a better way, this rubric overlooked the capacity of a State to collect taxes on a proportional level. Again, a State like Kerala is relatively smaller than Uttar Pradesh, Bihar, or Rajasthan, thus having a lesser number of people who pay taxes. The proportion of population paying taxes may be the highest in Kerala, but if its overall population capacity is lesser than Rajasthan, the former would receive lesser tax devolution in comparison to the latter – even if the latter’s tax collection in proportion of its population is lesser than the former. The method’s focus thus shifts again to a State’s latest population demographics; although the formula ostensibly aims to deviate from it by introducing the new TFR standard. Still, these financial gaps can be filled by the grants-in-aid and disaster management funds which were formulated in the FCR, through which they dispersed extra funds to States under specific sectors, such as healthcare, nutrition etc. The FCR did not provide for how much a State would get, and rather laid down the total amount which would be dispersed by the Centre collectively for all States. Many of these allocations are subject to the expenditure the government makes – something which the FCR itself acknowledged (p.108). Thus, they merely determine the standards on the basis of which the financial resources are to be distributed and did not recommend the actual amount – thereby leaving it to the discretion of the Centre to distribute grants-in-aid and disaster management funds. The 15th FCR also complained about there being no accurate disaster database at the national level, owing to which “developing a risk index of greater complexity and accuracy” was “found to be difficult” (p.102). Accordingly, the FC had to make a mechanism on its own, through which it allotted scores based on the parameters of hazard probability and vulnerability, to States and determined their needs for disaster management funds. The whole complication seemed to stem from the lack of statistical aid that the centre and the states provide to the FC. Interestingly, the Sarkaria Commission Report (1983) has noted that Indian States desired for the FCR recommendations to “be implemented in toto” (¶10.3.27). The FC, after all, is a politically neutral expert body. Although the Centre cannot influence the manner in which the FC functions, there lies a certain level of administrative discretion with the Centre to disperse financial resources to States – which it may artfully exercise by limiting the scope of the FCs recommendations through the TOR made under Article 280(3). Somewhere, the Central government seems to have done so for the 15th FCR. Instances of States opposing the methodology reference to the FC under the TOR raise suspicion of whether the Centre inadequately, and colourably so, consulted and deliberated with the States before formulating the TOR; and whether the Centre and States aid the FC with relevant figures (such as the disaster database) to formulate better recommendations than how they eventually were. The Way Forward The Supreme Court (“SC”) in State of MP v. Bharat Singh(1967) has noted that India’s federal structure is founded on the principle of Rule of Law and governance “in accordance with the will of the majority of the people”, and it is layered enough to include the will at both the Central and State levels. Such federal structure may be maintained by the active, and publicly evident, participation of State governments prior to the formulation of the TOR. The SC in State of NCT of Delhi v. Union of India (2018) threw light on the principle of cooperative federalism and noted that the Centre and State are supposed to work in tandem with one another. The Centre is not the jack-of-all in deciding what is best for the citizenry at the grassroots level – something which the State governments generally know better about. At the same time, States’ participation in formulating the TOR,and adequately supporting the FC with statistical data, would aid and enrich the FC in making better recommendations. Federal communication and cooperation prior to revenue distribution is essential, as the recommendations in FCRs lay the groundwork for the allocation of funds in Central and State consolidated funds – which they would use for their day-to-day functioning. Thus, the TOR must be formulated in consultation with the States so as to give a broader framework to it – within which the FC recommends devolution of revenue in the best manner possible. Obverting the present Constitutional arrangement would go a long way in improving the overall standards of (financial) administration in India. - Ashwin Vardarajan
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