South India vs North India in battle for Central funds: How Finance Commission's changing norms impact funding

There's friction between the BJP-led NDA government and the four South Indian states and it's only getting worse. The latest war of words came following the central government's recommendation to the 15th Finance Commission of using population data from the 2011 Census, instead of the 1971 Census, for distribution of central tax revenues.

On Friday, Karnataka chief minister Siddaramaiah said the move, if considered, would affect the "interests of the South" and called for state leaders of Tamil Nadu, Kerala, Tamil Nadu, Telangana, Andhra Pradesh and Puducherry to "resist" it.

Echoing similar sentiments, DMK working president MK Stalin wrote to Prime Minister Narendra Modi and chief ministers of 10 non BJP-ruled states expressing his concerns about some of the terms of reference (ToR) for the 15th Finance Commission. Calling it "ill-conceived", he said that it will affect equal distribution of central tax revenue among the states and reduce the fiscal capability of states to that of municipalities.

Before we plunge into what the clamour around the 15th Finance Commission and the southern states is all about, here's a brief look at what is the ToR that has pinched these aggrieved leaders.

How much of central funds do states get

The Finance Commission is a crucial constitutional set-up which decides every five years the ratio in which central tax revenue should be divided among the different states. All the states and Union Territories in India are collectively allocated 42 percent of the central taxes collected each financial year. The remaining 58 percent is for the Centre to use for national purposes. But the ratio in which the 42 percent gets divided among the different states is decided by the Finance Commission.

File image of Karnataka chief minister Siddaramaiah. Twitter@siddaramaiah

On 27 November, 2017, the Ministry of Finance issued a notification constituting the 15th Finance Commission under the chairmanship of NK Singh. The Commission has to hereby submit its report for 2020-2025 by 30 October, 2019.

In the same notice, one of the ToR stated that the "Commission shall use the population data of 2011 while making its recommendations". Traditionally, the previous Finance Commissions used population data from the 1971 Census as a standard. In fact, Lok Sabha constituencies were also divided based on this data and is set to remain frozen this way until 2026. The reason the 1971 Census was used as the standard is because it was the last Census before aggressive family control initiatives were implemented.

The decision to include 2011 Census was first introduced in the 14th Finance Commission, which gave a 10 percent weightage to the 2011 Census while allocating the central tax revenue. The political consensus was that the ratio of distribution cannot be arrived at based on current population after asking states to implement family planning measures, writes Nilakantan RS in The Wire.

The argument the southern states are making is that in the decades between 1971 and 2011, these states saw a steady decline in population growth rate, whereas northern states showed no such sign. The contention made by leaders like MK Stalin and Siddaramaiah is that using the 2011 Census data would result in a much reduced flow of central funds to the state, which they term as "punishment" for investing in education and health schemes to reduce the fertility rates and see an uptick in literacy rates.

Is it unfair to southern states?

One of the ToR asks the Finance Commission to incentivise "efforts and progress made in moving towards replacement rate of population growth". As joint secretary of the 13th Finance Commission, V Bhaskar notes in the Economic and Political Weekly, the replacement level fertility rate is defined as the total fertility rate (TFR) of 2.1. Out of the 29 states in India, 18 have already achieved the desired replacement rate of 2.1 or less, including all the southern states.

The ToR suggests that the Commission should provide incentives to the remaining 11 states to reduce their TFR, to which other states may feel they are being "penalised" for being achieving their targets. This asymmetry is exacerbated when the 2011 Census data is used for the same.

Representational image. PTI.

Female literacy rates in states like Kerala and Tamil Nadu are much higher than in states like Bihar and Uttar Pradesh. This shows a correlation between education and health; states with better literacy seem better prepared to implement family planning measures.

As per the The Wire's report, between 1971 and 2011, Tamil Nadu and Kerala showed an absolute population growth of 56 percent and 75 percent respectively — the lowest among all the states. Most other states showed an increase in the population growth exceeding 100 percent. Uttar Pradesh's showed an absolute population growth of 138.02 percent, while Jammu and Kashmir recorded the highest at 171.82 percent.

When the 14th Finance Commission introduced the change in ratio by including the 2011 Census data, it translated to a revenue loss of Rs 6,000 crore for Tamil Nadu, 19 percent compared to the 13th Finance Commission's allocation ratio, making it the worst affected state. If the 2011 Census data is solely used by the 15th Finance Commission, it could result in a loss of nearly 70 percent of central tax revenue it was allocated by the 13th Finance Commission, the report further stated.

The argument these states are making is to achieve these development indicators, they announced separate welfare schemes, be it making mid-day meals universal or allowing easy access to menstrual hygiene to lower dropout rates.

What pays for farm loan waivers

Writing for BloombergQuint, Praveen Chakravarty explains how the farm loan waiver scheme announced in Uttar Pradesh last year works. The Yogi Adityanath-led government had announced a Rs 36,000 crore farmer loan waiver, above the Rs 50,000 crore budget deficit the state faced. As Uttar Pradesh itself couldn't raise that much money, it would normally turn to the Union government to dish out a loan worth the loan waiver amount or act as a guarantor for its borrowings.

The article notes that Maharashtra, Tamil Nadu, Gujarat and Karnataka alone contribute to more than half of the central government's tax collections. On a per capita basis, a person from Maharashtra contributes nearly Rs 33,000 per annum to the Centre's tax basket, while a resident from Gujarat, Karnataka or Tamil Nadu contributes roughly Rs 20,000 each year to the Centre. In stark contrast, an Uttar Pradesh resident contributes just Rs 7,000 per year.

If the 2011 Census data is applied to determine the devolution of taxes ratios by the 15th Finance Commission, there is a high chance it will increase the social and economic disconnect between the North and the South in India.

Opposing arguments

However, they are several arguments that explain why using the 2011 Census data may not affect a state's share in the central pool of taxes adversely. Commission chairman NK Singh earlier reasoned that the terms of reference of the 15th Finance Commission provide for incentives to states that have seen controlled population growth and so it balances out the concerns.

In another article published in The Wire, Alok Prasanna Kumar writes that because the ToR says that the 2011 Census data be used, it doesn't mean the Commission cannot use data from any other Census or necessarily give it the weightage based on the current population. He also argues that each state has two major sources of revenue — taxes collected by the state and the state's share of taxes as guaranteed under the Constitution.

In this case, not all states are equally dependent on funds from central taxes. It turns out that states with low development indicators (Bihar, Meghalaya, Mizoram etc) are more dependent on these central funds.

On the other hand, southern states like Karnataka, Kerala, Tamil Nadu and Andhra Pradesh generate roughly 67 percent of their revenue from the respective state taxes levied. Only 30-33 percent of revenue is received from the Centre. This shows that the 15th Finance Commission's recommendations will affect only how much revenue a state receives from the Centre, and not how much revenue the state can raise through its own taxes.

Despite the above arguments, however, southern leaders continue to fear that the Centre's decision seems to be a bid to eventually move towards using 2011 Census data to determine the number of Parliamentary seats allocated to states, according to a report on Scroll.

If that is done, the southern states will be allotted fewer seats in Lok Sabha and Rajya Sabha as well, thereby reducing their representation in the Parliament.