India's twelfth finance commission : a view from Kerala

Abstract

The focus of the paper is to review the Terms of Reference (TOR)
\nof the Twelfth Finance Commission with special reference to Kerala.
\nIt also critically examines the emphasis on fiscal deficit reduction without
\npaying attention to its quality and finds that this has led to the Centre
\nand the States resorting to a softer option of cutting productive capital
\nand necessary maintenance and social sector expenditure. This is likely
\nto have adverse consequences on equitable growth and to impede the
\nprocess of relieving the economy of structural constraints on growth.
\nThere is an urgent need for analysing the quality of fiscal consolidation
\ninstead of focusing merely on quantity of reduction of deficits as a
\nproportion of Gross Domestic Product (GDP). The study hence suggests
\nincorporating the concept of Quality of Fiscal Discipline.
\nIt is found that there has been an enlargement of the scope of
\nFinance Commissions [since the Eleventh Finance Commission (11th
\nFC)] into mandates for recommending mechanisms for achieving
\nmacroeconomic balance, equitable growth, and suggestions for
\ndisinvestments and privatisation, while its role in the traditional area of
\ngrant devolution has been restricted to non-Plan grants only. In fact, the
\nenlargement of the role in the traditional area of grant devolution would
\nbe more desirable.
\nThere is sufficient scope for augmenting resource mobilisation
\nfrom direct and indirect taxes at the Central level. Emphasis is to be
\nplaced on integrating services and manufacturing into a single CENVAT
\n(Central Value Added Tax) and on direct taxes reform. The second
\ngeneration tax reform should concentrate on States’ tax administration
\nand inter-State coordination prior to moving on to a State level VAT.
\nThere is need for a constitutional amendment to place service tataxation
\nin the Concurrent List and enable States to tax more services. On the expenditure side, steep increases in items like wages and
\nsalaries and interest expenditure are unlikely in the near future.
\nHence maintenance and social sector expenditure should not be
\nsacrificed. At the same time, efficiency in spending and cutting
\nunproductive expenditure and leakages should be strictly monitored. A
\ndecentralised district level monitoring system for maintenance
\nexpenditure of capital assets is also suggested. The paper argues that
\nbringing privatisation in the Terms of Reference of the Finance
\nCommission seems avoidable. It is also felt that more effective time
\nbound implementation of State Finance Commission Reports is needed.
\nAlong with devolution of funds, transfer of administrative functions is
\nnecessary for avoiding duplication of expenditure.
\nAs for Kerala-specific issues, it is found that achievements on the
\nhuman development front are not rewarded. Certain changes in the
\nexisting criteria (of the Eleventh Finance Commission) are hence
\nsuggested. Kerala’s tax effort, though better than richer States like Punjab,
\nis facing structural constraints. The fast expanding services sector is
\noutside the tax net of the State. The tax-GDP ratio of Kerala showed a
\nmild decline at 9.84 percent in the 1990s as compared to 10.29 percent
\nin the 1980s despite a much higher growth rate of State Domestic Product,
\nmainly because the State was not able to tax the dominant sector of the
\nState Domestic Product, that is, the services sector.
\nKey words : finance commission, fiscal deficit, revenue mobilisation,
\ndevolution
\nJEL Classification : H77, H60, H20