REVIEW OF FISCAL POSITIONS

All fiscal indicators warranted reversal in the trend of dilution in the quality of Fiscal
management during the review Period of the commission which according to the FFC, have to
be anticipated in the award period. However, it wasn't sure whether the projections will turn
out to be optimistic or pessimistic. Its judgement depended upon its desirability, feasibility and
possible implications. The union government’s projections in regard to both macro and fiscal
position should be the anchor along which the FFC would proceed to strike a balance between
the two. FFC also articulated that the fiscal position of union can be improved through GST,
sale proceeds from spectrum, increased disinvestment of shares in public enterprise and by
other means possible. FFC recognized that there is ample scope for accelerating fiscal
consolidation if there were the will and skill to do so. The fiscal position of all states have
shown improvement in terms of quality and quantity during the review period and the states
had not fully utilised the fiscal space available to them to incur capital expenditure.

INTERGOVERNMENTAL TRANSFERS

The focus of FFC was to concentrate on the composition on qualities of transfers from Union
to states. The Consolidated public finance and intergovernmental transfer were analysed. A
greater expansion in the fiscal activity of the Union than of the State was observed. Transfers
from the Union to the States increased substantially and Finance Commission Transfers and
other transfers exceeded the indicative ceiling prescribed by the previous finance commissions.
FFC viewed several aspects of union and state finances in order to review other governmental
transfers, namely, a) union finances as a whole, b) total transfers from the union government,
c) the revenue expenditure of Union and State as a whole, d) the consolidated public debt of
the Union, the states and their respective shares. It concluded that burden of Fiscal
consolidation rests heavily on the union government and that it was not possible to increase the
level of aggregate transfer from Union to States.

UNION FINANCES

UNION LIST includes the subjects on which only the Union government can make laws.

STATE LIST includes the subjects on which only the states can make laws.

CONCURRENT LIST includes the subjects on which both the union and the states can make
laws but the union have an upper hand in making laws on these subjects.

The Government of India borrows from the market in order to lend to the states. The FFC took
the responsibility of balancing Union and States revenue expenditure power with expenditure
responsibility listed in the 7th schedule of Constitution. Hence the priority of FFC was to
provide appropriate fiscal space to the union government for expenditures and to recognise and
articulate the space for revenue mobilization. It also explicitly provided fiscal space for union
government to carry out the transfers to the state by way of expenditures with externality
considerations and equalization in select sectors. In the treatment of committed expenditures,
FFC took into account the resources required for the union to meet its commitment for
providing the public services detailed in the union list and the expenditure commitment of the
union government listed in the Concurrent or State Lists. The FFC considered the magnitude,
legitimacy and appropriateness of union transfers to States outside the mechanism of finance
commission keeping in view the constitutional provisions. A challenge in this regard was the
expenditures on the ongoing schemes on the subjects of concurrent list which were being
funded by both the Union and the states.

STATE FINANCES

The FFC followed past practices in the assessment of revenue expenditures but with some
notable departures such as revenue expenditure under plan was also included. The FFC
considered own tax revenues of states as a single category for the assessment. In making the
projections a two-step methodology was followed. The first step involved the reassessment of
the base Year 2014-15, the second step involved application of normative growth rates for the
projections. This resulted in an improvement in the assumed aggregate tax-GSDP ratio from
8.26% of GSDP to 9.0% in the terminal year. The liabilities of interest payments were treated
as committed expenditure and were provided in the assessment of needs. The fiscal deficit for
each year was 3% of GSDP (Gross State Domestic Product). The FFC did not consider any
proposal for debt-restructuring. The FFC also accepted the pension expenditure for the base
year provided by the states and assessed this expenditures in a manner that reflects true pension
liabilities for the assessment period, it measured the economic incidence of pension liabilities.
FFC adopted norms that reflects the need of state to make adequate expenditure on services
such as police and general administration. FFC attempted to address the goal of equalization
of expenditures across the states in terms of per capita expenditure.

VERTICLE BALANCE

It refers to the distribution of taxes between the union and the state. The approach to vertical
devolution was governed by three factors, a) the spirit of constitutional provisions, b) the
concerns about the fiscal space expressed by the states and the union, c) the need for clarity on
the respective functional and expenditure responsibilities of the Union and States. There was
no scope to reduce the fiscal space available for discharging its responsibilities in the Union
List and against this background a consolidated view of the aggregated transfers from the
Union and States was taken while recognising that the tax devolution should be the primary
route of transfer of resources to States on the ground that it was conducive to sound fiscal
federalism. It recognised that in case the formula based transfers do not meet the needs of the
specific states, they need to be supplemented by grants-in-aid. FFC recommended increasing
the share of tax devolution to 42% of the divisible pool which would serve the twin objectives
of increasing the flow of unconditional transfers to the states and leave appropriate fiscal space
for the union to carry out its functions, which was previously 32% of the divisible pool.
However there has been an enhancement in the share of unconditional transfers to the state.
The balance in fiscal space remains same in quantitative terms, but tilts in favour of states in
qualitative terms through the shift in favour of devolution and hence fiscal autonomy.

HORIZONTAL BALANCE

It refers to allocation of taxes among the states. The FFC was guided by the following criteria
of the earlier finance commission, a) population and income to reflect needs, b) area and
infrastructure distance to indicate cost disabilities; and c) fiscal indicators relating to tax and
fiscal discipline to asses resources. In the assessment of needs, revenue expenditure on account
of plan were also included. The three features of this criteria are: a) to icdicate demographic
changes a weight of 10% was given to the 2011 population census along with a weight of
17.5% to the 1971 population census on the basis that using outdated population data was unfair
in the terms that public services should be provided to the entire population and, therefore the
needs should be assed for the latest population, b) Weight of 7.5% was assigned to the forest
cover to assess cost disabilities since the forest cover involves additional costs for the states in
provision of services to the population and they are deprived of resources for development due
to the restrictions imposed on the exploitation of ecological resources. This step incentivised
stats to have and maintain forest cover. The share of area of a state was also increased from
10% to 15% by the FFC to consider the disabilities arising out of large area. In order to ensure
that state with small areas do not suffer due to this, a minimum cap of 2% area was assigned to
states with area below 2%, c) The FFC continued with the weights for revenue disability.

The FFC did not take into account the fiscal performance criterion in tax devolution. Reasons
behind this are: 1) questions on the measurement of performance criterion, 2) it only reflects
the past trend and does not reward or punish the future behaviour, and, 3) there is no
comparable approach to evaluate performance of the union government.

LOCAL GOVERNMENTS

The recommendations of FFC in this regard are only meant to indicate measures to supplement
the resources available to the states to support local bodies which in turn are made on the basis
of the recommendations made by the State Finance Commissions. The SFCs do not exist in
many states or their recommendations are not up to date. The FFC concluded that the local
bodies are the responsibility of states and the State Finance Commissions are required to play
a key role in allocation of resources within a state. It noted that the FFC should not undermine
or enhance the statutorily determined role and functions of local bodies. As per its final
recommendations, the local bodies are required to spend almost all the grants only on the
services within the functions assigned to them without any intervention by the state or the
Union. Further distribution of grants within the local bodies was left to the State governments
provided it is based on the recommendations of FFC. In the absence of the SFC formula, a
default option was provided whereby the distribution was on the basis of 2011 population with
weight of 90% to population and 10% for area. The Scheduled areas under the Article 275 (1)
were excluded from the considerations of finance commission in the ToR and hence, no
allocation has been recommended to these areas.

GOODS AND SERVICES TAX

Due to the absence of clarity on the design of the GST and the final rate structure, the FFC was
unable to estimate revenue implications and quantify the amount of compensation. It
recognized that the union government may have to initially bear an additional fiscal burden on
this account and that such fiscal burden should be treated as an investment which is certain to
yield substantial gains in the future. It added the GST compensation in overall fiscal space
available with the union government. The FFC however, did not indicate any fiscal incentives
to the states to adopt such a tax nor did it indicate an appropriate design.
FISCAL ENVIRONMENT
The FFC aimed to create a fiscal environment that is sustainable, and also promotes equitable
growth. The review of fiscal environment by the FFC encompassed legal and institutional
aspects. A major problem faced by FFC in assessing this was the debt position of the state and
the union government. The FFC has recommended computing of extended public debt of both
the union and the state and presenting it as a supplement to the budget documents. 3% of GDP
was set up as the fiscal deficit targets for both the union and the state government to be
implemented by 2016-17. Many of the states adhered to the fiscal targets but the union
government wasn’t able to meet this target. With regard to states, some flexibilities were
provided to them. As a result of frictions between the union and the states, the FFC
recommended a discontinuance of operations of NSSF (National Small Savings Fund),
meaning that in future, the state governments will have to repay their dues under NSSF to the
union, the union will not be lending receipts under NSSF to the states. It also suggested
amendments in the FRBM Act (Fiscal Responsibility Budget Management Act) to dispense
with the concept of “Effective Revenue Deficit” and replacing the FRBM Act with the debt
ceiling and fiscal responsibility legislation, Article 249 of the Constitution.
FFC computed the implicit capital outlay of the union and each state and concluded that capital
outlay by the states put together is likely to exceed that of union, during the award period. To
provide adequate check and to improve budgeting practices and to monitor the fiscal rules, FFC
recommended the setting up of an independent fiscal institution reporting to the Parliament.