TERI (The Energy and Resources Institute) Workshop on ‘Fiscal Federalism and its Impact on Growth in Indian States: Role of Grants and Royalties’

As a backgrounder to our deliberation on fiscal federalism in India, let me begin with two points in comparative federalism and federal division of powers in India. We can delineate four models of federal division of powers in comparative federalism: (i) dualist, which demarcates the federal and provincial domains with a greater concern for exclusive assignments as in Canada; (ii) concurrentist, where most powers fall concurrently to both orders of governments as shared or coordinated jurisdictions as in the USA and Australia; (iii) integrationist, where most framework laws are made by the national parliament leaving it to the provincial parliaments to frame conforming laws and to the provincial governments to implement them as in Germany; and (iv) regulatory and interventionist, as in India where there is a tripartite division of powers through Union, State, and Concurrent lists but some important subjects like water, industries, mines, etc. figure in state list but are made subject to regulatory and developmental powers of the Parliament of India in ‘public’ or ‘national’ interest, to say nothing of the constitutionally contemplated national, state, and financial emergencies during which the federal structure is transformed into a unitary one.  About fiscal federalism in India, a historical fact to bear in mind is that the scheme is largely modelled on the classical Commonwealth parliamentary federations in Canada and Australia as evolved around the mid-1930s when the British Parliament designed the first federal constitution for India in the form of the Government of India Act, 1935, patterned mainly on the Canada Constitution Act, 1867, which was also enacted initially by the imperial parliament in London.
                Since the 2014 general elections, Indian federalism finds itself in a significantly different political ambience from what was prevailing for about two and a half decades since 1989. In the backdrop of first a decade of unstable multiparty coalition governments and later stable but excessively regionalised and fragmented federal governments, India came under a de facto one-party majority government of the BJP (Bharatiya Janata Party) led by Narendra Modi within the NDA (National Democratic Alliance) framework. The Modi Mandate produced a prime ministerial government at the Centre though it must contend with some continuing strong regional parties in some states and a Rajya Sabha still controlled by an opposition majority at least until 2018 or so. Moreover, in the state Assembly elections held since May 2014, BJP’s winning spree in Haryana and Jharkhand, and partly in Maharashtra (in strained pre-poll coalition with Shiv Sena) and Jammu & Kashmir (in strained post-poll coalition with PDP or People’s Democratic Party), came to be rudely punctured in the Delhi Assembly elections in February 2015, when the AAP (Aam Aadmi Party) rose Phoenix-like from its ashes in the parliamentary elections only a few months ago. Thus the centralist thrust under BJP/NDA is now countervailed by continuing or regenerated decentralist thrust. The point is that the situation is pregnant with the double possibility of both federal centralisation and decentralisation. Another dimension of public policy and governance pertaining to the present regime is the challenge of reconciling the tensions between inclusive economic development and divisive Hindutva, and Indian nationalism and regionalism verging on ambivalent separatism in the PDP-BJP coalition government in Jammu & Kashmir.
                The present political scenario marked by conflicting prospects portrayed above is also more or less similar in the domain of fiscal federalism in India today which is our concern in this workshop. I will elaborate this point more clearly below.
                 In the context of the fourteenth Finance Commission of India (FFCI) Report submitted  recently and the first full-year budget of the Modi government presented by finance minister Arun Jaitly on 28 February 2015, the air is thick with claims and counter-claims of who gets what, when, how, and how much or less. Arvind Subramnian, chief economic advisor to the Government of India calls it a ‘watershed’ in the history of Indian federalism, ‘just completely radical’ as the states under the FFCI recommendations will not only get an unprecedented raise of ten percentage points from 32 to 42 in the divisible pool of national revenue but also the freedom to decide and plan how that money will be spent. He added that the increase is also unprecedented in terms of non-plan transfers that the Finance Commission does along with tax, though if plan transfers are added it might be less.  But he hastened to add that now that tax devolution are recommended as the primary route of federal fiscal transfers, the correct way of looking at the transformation is from the perspective of enhanced fiscal balance and autonomy of the states. The finance minister holds out the fact of the Union government’s acceptance of the FFCI’s recommendations as his government’s commitment to ‘cooperative federalism’ promised in the BJP manifesto and the election campaign. Political analysts also underline that the acceptance of the FFCI Report by the Union government marks several major shifts from the past. Apart from the sharp increase in the states’ share, now assessment of revenue deficit will also take into account a government’s plan revenue expenditure. Moreover, the long-held old distinction between chronically deficit special category states and other states is done away with for a different way of ad hoc special grants-in-aid. Further, the Union government would also desist from making tied sector-specific grants and subjecting grants to conditionalities. 
                The fourteenth Finance Commission has also significantly revised the criteria and weight of tax devolution to states as compared to the thirteenth. The weight of fiscal need or capacity of the state (measured in terms of distance from the highest per capita districts) has been increased from 47.5 per cent in the previous Report to 50 per cent in the present. The weight of the area of the state has been increased from 10 to 15 per cent. The criterion of human head count has been made more differentiated and nuanced. Departing from the simple concept of population (1971 census), it has been disaggregated into population (1971 census) and demography (2011 census). The former has been assigned a weight of 17 per cent, and the latter 10 per cent. The criterion of fiscal discipline, which carried the weight of 17.5 per cent in the thirteenth Finance commission Report, has been abandoned. A new criterion of forest cover has been added with a weight of 7.5 per cent.
                Fiscal federalism in India today sure stands at a cusp – a point of transition between two different states. We might as well call it a cusp of fiscal adulthood of the states of the Indian Union. The cusp of political adulthood came earlier – roughly from the early 1990s onwards. During this earlier phase the twin processes of political federalisation in the trail of the decline of Congress dominance, on the one hand, and economic liberalisation and globalisation, on the other, had augmented the autonomy of the state governments as well as the private sector of the national and multinational economy. During this earlier phase, the Centre’s capacity to lord politically over the states passed out for all practical purposes, leaving the field open for the states to tread on the path of political autonomy. But, given the asymmetry between the assignment of larger tax bases to the Centre and greater social sector responsibilities to the states in the constitution, the latter were constrained by the limits of their fiscal resources. They also lacked representation in the institutions of fiscal and monetary policy-making such as the processes of appointing the members of the Planning Commission and Finance Commission and boards of the Reserve Bank of India. All these limitations are not exactly made up even now. Yet under the newly constructed fiscal regime by the FFCI and its acceptance by the Modi government, the states’ fiscal resources and autonomy are now significantly expanded. There is also the promise of their representation equal to the   Union government’s in the Policy Foundation or NITI Aayog, the body that has recently been set up by the Modi government to replace the extra-constitutional Planning Commission, which had dominated the fiscal space of the Indian political system. True, there was also the constitutionally mandated Finance Commission appointed every five years by the President of India to review and recommend the patterns of revenue sharing   between the two orders of governments in India, including more recently local governments as well. The states always preferred the Finance Commission over the Planning Commission as the former was constitutionally autonomous whereas the latter, set up by a cabinet resolution of the Nehru government in 1950, was a political creature of the government of the day. The Justice Sarkaria Commission Report on Centre-State Relations (1988) had rightly recommended constitutional entrenchment of the Planning Commission, but no government ever implemented it.
                As a parliamentary federalist, I welcome the enhanced political and fiscal autonomy and resourcefulness of the states of the Indian Union. As to the impact of this event on economic growth in the states, I can only be cautiously optimistic.  The trends in this regard have been mixed. In the recent past, some states with faster rates of growth earlier, e.g. Punjab and Haryana, tended to slow down or slide back, while some previously backward states in the Hindi heartland have recently registered faster or even fastest rates of growth. Similarly, among the recently newly created states, Uttarakhand and Chhattisgarh have done reasonably well, while Jharkhand and Telangana have been much in the news for rampant corruption and rabid nativist and discriminatory politics.
                I wish to flag two reasons for my scepticism about a robust trust in the capacity of the state governments to make the most of their considerably enhanced fiscal resources and autonomy.  First, the state party systems are in a terribly bad shape. Undemocratically organised and devoid of internal democracy in their functioning, parties in the states are ill-equipped for sound public policy-making and good governance. Most parties are dynastic or family-dominated or personalised instruments of power. They are also riddled with politics of corruption and criminalisation. Second, the administrative apparatus in most states has also suffered a precipitous decline and degeneration, often in dubious collusion with the political class. Not only the officers of the state civil services but also the members of the once famed all India Services, who occupy the top administrative and police positions in states (as also at the Centre), have generally deviated from the norm of political neutrality and become a part of the nexus with corrupt and criminal elements among the political class. Unless these two crucial institutions of the political system are systematically reformed, it is difficult not to feel that the democratic and developmental performance in the Indian states would continue to be problematic.
                 I thus find myself in the company of Abhijit Sen, one of the four members of the of the fourteenth Finance Commission who wrote a note of dissent in the report suggesting that devolution to the states ought to be pegged at 38 per cent in the first year and its enhancement to 42 per cent should be made subject to an agreement to meet a set standard of fiscal management.  In an article he subsequently published in The Indian Express (New Delhi, March 3, 2015: 10), Sen explained: ‘[W]hile I think the 14th FC has delivered a strong push towards true federalism, I do not regret my dissent either. There will certainly be major benefits from federalism in years to come, especially if the NITI Aayog can play a mentoring and incentivising role.’
                Nevertheless, to conclude on an optimistic note, there are some hopeful signs.  For one thing, there is some change in the electoral behaviour preferring development (bijli, sadak, pani/electricity,road, water) over ascription and primordial considerations. For another, the increased political competitiveness among the states will produce a race to the top for formulating public policies combining human development and state gross domestic product growth and good governance. In fact, Saminathan S. Anklesaria Aiyar envisages a new role for the NITI Aayog,as a national equivalent of the IMF and World Bank, in sponsoring a sort of ‘a social and economic Olympic Games in which states vie with one another in fields ranging from GDP growth and improved school and health outcomes to agricultural yields and job creation.’ It is particularly imperative to generate  a virtual developmental spiral, particularly in view of the fact that even relatively developed states and fastest growing developed and backward states are riddled with high corruption and bad governance (Aiyar, ‘Start an Olympic-style  competition for state governments,’ The Sunday Times, New Delhi,  March 8, 2015: 16). Thirdly, dynastic succession in most parties from Indian National Congress to regional parties like, National Conference in Jammu & Kashmir, Shiromani Akali Dal in Punjab, Samajwadi Party in Uttar Pradesh, Rashtriya Janata Dal in Bihar, and Dravida Munnetra Kzhagam in Tamil Nadu do not show much promise or inspire confidence in their ability in the realms of public policy making, governance, and democratic regeneration. The Trinamool Congress in West Bengal, which came to power on the agenda of ‘parivartan’ (change) ending nearly three and a half decades of uninterrupted rule of the Communist Party of India (Marxist)-dominated Left Front, became bogged down in authoritarian personality cult of Mamata Banerjee and political corruption of unprecedented proportions in its  very first term. The new electorate aspiring for a corruption-free and pro-poor governance set a new trail by giving a chance to an entirely new party like the Aam Aadmi Party (AAP) in Delhi Assembly elections in 2014 and 2015. Its  unexpected levels of success simply on the strength of its as yet unproven claim to provide an alternative model of a truly democratic party and participatory and clean governance would seem no less than a political miracle. The party emerged from a flash anti-corruption movement led by Anna Hazare in the Spring of 2011, after Arvind Kejriwal established it disregarding the opinion of his mentor Anna that the flock should stay a part of the non-party political movement, which was however losing momentum.  Yet the working of the AAP party and government in Delhi has not so far offered convincing evidence that it is all that different from the prevailing political culture and governance of other political parties in India. Another reformist party in Andhra Pradesh, Lok Satta Party led by an Indian Administrative Service (IAS) officer Dr Jyaprkash Narayan who resigned from IAS to found it, has made ripples in recent decades and done some exemplary work. But it has not made much headway either as a movement or a party.  Dr Narayan is its sole Member of the Legislative Assembly from the techno-township Cyberabad. The past reformist thrusts by mass-movement-cum-party formations in the late 1960s by Dr Ram Manohar Lohia, in the late   1970s by Loknayak Jayaprakash Narayan, and in the late 1980s by Vishwanath Pratap Singh created greater political stirs and electoral changes, but all sooner or later passed out without much lasting impacts.  
                Under the circumstances, it is imperative to implement the recommendations of the National Commission to Review the Working of the Constitution (NCRWC) (2002), chaired by Justice M. N. Venkatachaliah. It recommends a comprehensive law regulating registration of parties and alliances of parties, democratic reconstruction of parties through regular elections at various levels every three years, and transparent and publicly audited funding from public and/or private sources. Under the proposed law, parties must require their candidates to declare their and their spouses’ assets and liabilities at the time of filing their nominations for an elective office. Parties must not nominate a candidate if one was convicted by any court for any criminal offence or if courts have framed any criminal charge against one. These reforms in the party and electoral systems would also result in improvement in the administrative system. For, as Loknayak Jayaprakash Narayan aptly remarked, it is politics that is the gangottary (source) of corruption.
A subsequently revised text.  Delhi, 8 March, 2015.