India - Would Centre-state fiscal dance go berserk?

Those who argue that India should be an integrated market and that states ought not to be doing tax arbitrage to woo investors would find themselves in a public fight in the coming months. States’ fear of a likely further pruning of their revenue-raising ability and borrowing freedom would escalate during this period and they are most likely to protest.

Three agencies — the technical committee for devising the goods and services tax (GST) structure, which was formed jointly by the Union finance ministry and the empowered committee of state finance ministers; the soon-to-be-established 13th Finance Commission; and the recently-constituted commission on Centre-state relations headed by Justice Madan Mohan Punchhi — are pondering over Centre-state relations.

While GST technical committee would firm up its views soon for the benefit of the Centre and states, the other two have to complete their work in the next two years (forget the bureaucratic leaning to prolong vocation).

GST committee’s mandate is to find which model of nation-wide value-added tax (VAT) would suit India. Whether it should be a single rate tax or a dual rate one, who would levy and collect it, etc are the main questions.

Integral to this committee’s mandate is, therefore, a couple of Constitutional questions — whether to withdraw states’ right to tax sales and whether states should be given concurrent powers to tax services. (The Centre had designated itself as the sole authority for levy of service tax through a Constitutional amendment in 1994).

The Finance Commission’s job, of course, is to ensure a matching transfer of resources from the Centre to states in the form of devolution of central taxes and grants. This again is a constitutional requirement.

The Punchhi Commission, which follows the Sarkaria Commission, has a much wider mandate. Unlike the Finance Commission, which would work within the confines of a constitutionally granted space, the Punchhi Commission has the freedom to propose to alter, even radically, the existing Centre-state equations, including in the area of economic and social planning, governance and financial matters.

It would seem that the terms of reference to the Punchhi Commission don’t give it an entirely neutral platform. Arguably, it is expected to favour the concept of unified Indian market. The commission is supposed to have “particular regard to...the need for freeing inter-state trade in order to establish a unified and integrated domestic market.”

It would also have to place under scanner and re-define “the role, responsibility and jurisdiction of the Centre vis-a-vis states in promoting the concept and practice of independent planning and budgeting at the district-level and...in adopting approaches and policies based on positive discrimination in favour of backward states”.

There is clearly a lot of overlapping among the jobs given to the above three agencies. A recent news report said the 13th Finance Commission would prepare a road map for introduction of GST. This means the GST technical committee, comprising the Centre and states, would have to work in conjunction with the Finance Commission.

But there is no sign that the Punchhi Commission, which is authorised to review the Centre-state relations in totality, will be kept in the loop. The alienation of this commission from GST structuring process is despite the fact that it would also have “to look at the need and relevance of separate taxes on production and sales of goods and services subsequent to the introduction of VAT regime”.

“If necessary, we would even suggest rearrangement of some Constitutional provisions regarding the Centre-state financial relations, including the powers for collection of taxes, etc,” Punchhi Commission member NR Madhava Menon told ET. So, while some fundamental policy questions are being deliberated upon, a parallel process that takes the policy stance as a given is also gathering momentum. This would inevitably lead to contradictions and confrontations in future, besides precipitating wasted work.

“The Union finance minister’s announcement that GST would be in place by 2010 is a unilateral one. There is no guarantee that states would agree to this. After all, for Constitutional amendments of this sort, you need consent of state legislatures,” said National Institute of Public Finance & Policy senior fellow Tapas Sen. One option for the Centre to push GST is to sell it to states as a revenue-neutral device. But since states will have to surrender considerable fiscal space and authority for this and excessively rely on the transfers from the Centre, there would still be strong resistance.

In a recent article, West Bengal finance minister and chairman of the empowered committee of state finance ministers, Asim Dasgupta, criticised what he called the Centre’s “gross failure” in decentralisation of financial resources to states. His argument is that states whose combined annual development expenditure burden is one and half times that of the Centre nevertheless account for about 40% of the total revenue collected.

“But that is because most states showed a distinct inability to collect taxes,” said Icrier director and chief executive Rajiv Kumar. He added that a universalised indirect tax system was crucial for the creation of an integrated market which would catalyse growth. “Allowing states to compete by giving tax incentives to the investors can be distortive,” Mr Kumar contended.

There is no dearth of counter-arguments. Won’t states have better ability to implement development programmes at the local levels?

Don’t many centrally sponsored schemes in sectors such as health, education and agriculture infringe upon the states’ constitutionally granted governance space? Is such interference desirable? (Note that Punchhi Commission is asked to comment on the “independent (central?) planning and budgeting” at the district level).

“Much more development work can be done at the level of the third tier of government,” Mr Kumar said, agreeing to what the Centre apparently intends for — circumvent the states to implement centrally sponsored schemes.

Despite the award of the 12th Finance Commission, the net central transfer to states — taxes and grants — as proportion to its revenue receipts, has fallen from 32.7% in 1990-91 to 29.5% in 2004-05, Mr Dasgupta pointed out, adding that states’ share of central tax revenue should be at least 50%. More than 85% of the sovereign market borrowings is by the Centre.

Should the power of public debt stewardship be vested with the Centre only? Shouldn’t there be an incentive for states to improve their finances and borrow at lower rates directly? How far is the notion that Centre is a better fiscal manager than states true? Won’t independence improve states’ managing prowess?

No doubt, hindrances faced by traders at borders — whether fiscal, administrative or infrastructural — are a major problem that constrains the economy. It is desirable to have a great degree of pan-India uniformity in taxes. In that sense, it is unrealistic to expect the Centre to adopt laissez-faire.

But the Centre should not go beyond the point of coaxing states to minimise the rate disparities and embrace VAT that would reduce cascading of taxes. Given the complex nature of Indian polity and the dismal status of social development, states would legitimately spurn any usurpation of their powers. Even with much larger resources in hand, the Centre can’t claim it is far more competent than states, when it comes to governance. It has no moral authority to admonish states.