16th Finance Commission on a devolutionary road

The 16th Finance Commission, headed by Arvind Panagariya, has, in a departure from recent history, not been issued any specific tasks, leaving it free to determine the scope of its recommendations. This gives the commission more elbow room to go about strengthening fiscal federalism. On paper, its job is to ensure balance in resource transfers between the Centre and states, and among states. But the task is nuanced. States grudgingly relinquish their resource-raising capacity and resent any loss of agency over expenditure. The Centre, on its part, would like to see the larger devolution to states put to responsible use and tries to nudge states towards fiscal responsibility. States also need to be convinced that the formula for dividing resources does not disincentivise outperformance and delivers on curbing unwarranted migration.

The 16th Finance Commission has the freedom to choose its population data. But it will not have the 2021 census data to go by. Population is a key determinant of how much a state receives as its share of the divisible pool of government resources. States that have stabilised their population growth, and, thereby, bumped up their per-capita income, would have gone further down that path between 2011 and 2021. Without the 2021 data, however, there would have to be an approximation of the performance of lagging states. The extent of migration over a decade would also involve an element of uncertainty. This makes assessment of social sector spending outcomes more difficult than it should be.

The Centre now draws less from the combined resource pool than the states, but is directing spending through capex and welfare payments. As the gap widens, states would need more unencumbered finance for their larger responsibility. The Centre is trying moral policing to drive fiscal prudence, but is not in a position to lead by example. This will be a subtext for further devolution.