Despite higher allocation of Central funds to States, why has social spending dropped?

The Reserve Bank of India’s latest annual study of state budgets, based on budget estimates of 2015­16, will invite a we­told­you­so chorus from critics of the award of the Fourteenth Finance Commission (FFC) and the government’s acceptance of it.

That’s because the RBI study shows that states have cut back on social sector spending in 2015­16, the first year of the award period (2015­2020). Social sector spending as percentage of GDP came down from 7.9 percent in the revised estimates (RE) of 2014­15 to 7.4 percent in the budget estimates (BE). As a percentage of total expenditure, it came down from 45 percent to 44.6 percent.


In line with the FFC’s award, the central government had increased the share of states in central taxes – which are unconditional transfers ­ from 32 percent to 42 percent. But there was a simultaneous cutback in the conditional transfers in the form of grants for specific schemes and programmes initiated and managed by the centre. Eight centrally sponsored schemes that were funded by the central government were de­linked from central support while the funding pattern on some other central sector schemes was changed, with the states being told to foot a larger portion of the bill than earlier.

Critics warned that this would have adverse consequences for development spending in states, since there would be no check on how untied transfers were used and that states would cut back on productive spending when faced with fiscal constraints.

Sure, that seems to have happened. The RBI study shows that total central transfers to states fell by 0.3 percent of GDP between 2014­15 RE and 2015­16 BE. While states’ receipts in the form of share in central taxes increased 32.6 percent, the receipts through grants from the centre fell 11.8 percent during this period. This obviously had an impact on spending patterns, with a fall in both revenue expenditure and capital expenditure as percentage to GDP.

The consolidated revenue expenditure­GDP ratio of state governments fell from 14.6 percent of GDP to 13.9, mainly, the report notes, due to lower growth in its development component. The report flags the cut in revenue expenditure for sectors like housing, urban and rural development, soil and water conservation, irrigation and flood control, while simultaneously committed expenditure shows an increase, primarily on account of pensions.

Capital expenditure also has slowed down, from 2.9 percent of GDP to 2.8 percent. The report rues the absolute decline in capital outlay on services like family welfare, water supply and sanitation, housing, food storage and warehousing, among other things. Now it can be argued that these are aggregate figures and may not take into account the fact that individual states may have different priorities, that one state may have cut the spending in, say, housing, because that was not a huge problem for it and used that money to up spending in say, education, because it was way behind other states in this.

That is a valid line to take. But when one finds that even at an aggregate level, growth in
spending on nutrition has been near stagnant (1.6 percent) and its share in expenditure in social services has fallen, then it is a source of worry. India can hardly be said to have won the nutrition battle decisively for states to compress expenditure on this head. But does that mean the FFC report was wrong to give more untied funds, and for the central government to accept it? No, it doesn’t.

Pick up any finance commission report and go through comments of state governments. It’s a common refrain: give us more untied transfers; free us from the tyranny of specific purpose grants (money to be used for specific schemes often in line with rigid one­size-fits­all guidelines drawn up in Delhi); since the bulk of social sector spending is in the states, give us the freedom to determine our priorities and design our programmes. It doesn’t matter if they are big states or small states, states ruled by parties in power at the centre or by those in the opposition; on this one point, there has always been a rare unanimity.

The FFC report notes: “The States have, therefore, suggested that the funds transferred by the Union Government for expenditure on State subjects through various Centrally sponsored schemes should be subsumed under the funds transferred through vertical devolution. The States have emphasised that there is a need to enhance the existing level of formula­based fiscal transfers, with such transfers conforming to the principles recommended by the Finance Commission.”

The FFC did what earlier finance commissions hesitated to. It gave them more non-discretionary unconditional funds in the form of higher tax devolution. This obviously had to be accompanied by a reduction in tied transfers – the conditional funds or specific purpose grants. Could the central government have not accepted these recommendations? It could not have.

The government has been giving the impression that it has been extremely large-hearted in giving states such a huge increase in tax devolution, but the fact is no government ever has dared to reject any finance commission’s recommendations with regard to tax devolution. The reports are public documents and it would have set off a huge centre­state tussle if the award was rejected or modified. This government, too, had to do the same.

But having got a higher share of non­discretionary funds, states cannot now ask for an increase in tied funds as well. The FFC and the central government have treated them as responsible adults who don’t need someone looking over their shoulder all the time. It is now up to them to behave responsibly and re­prioritise expenditures in a way that maximises growth and welfare. Or they need to accept what critics of the FFC award imply – that states cannot be trusted with more fiscal and policy autonomy and that the centre needs to keep a tight rein on them. Are they willing to concede this point?

The RBI report exposes the double standards of states on another issue as well. They have demanded and got more fiscal and policy autonomy from the centre, through successive finance commission awards. But their own record in giving the same autonomy to local bodies by implementing awards of state finance commissions (SFCs) has been abysmal. The RBI report says: “SFCs were mandated to address the mismatch between the allocation of financial powers and responsibilities between the state governments and local bodies. After two decades of formation, this objective remain unfulfilled.”

States have been tardy in setting up SFCs, giving them the required information or implementing their awards. A table in the report shows that in some states the implementation of the SFC award has been delayed by more than two years; there is no information on implementation in the case of several. The message from the RBI report is clear – states want to have their cake and eat it too, without sharing with their subordinate governments. This is clearly unsustainable.

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Updated Date: Apr 11, 2016 15:07:57 IST

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