People's Democracy

(Weekly Organ of the Communist Party of India (Marxist)


No. 22

June 02, 2013


The Diminution of the Finance Commission


Prabhat Patnaik   


THE Finance Commission is one of the grandest institutions conjured up by the Indian Constitution. Its role is to overcome a basic anomaly in India’s federal structure, arising from the fact that while the state governments have the responsibility of carrying out substantial development expenditure, the revenues at their command are meagre compared to those of the centre. A Finance Commission therefore is constituted once every five years to decide on the magnitude of devolution of resources from the centre to the states and their distribution across states.


The job of the Commission being of such great importance, and its position being one that overarches both the centre and the states, the constitution of a Finance Commission should be front-page news. But that alas is not the case. The Fourteenth Finance Commission has been recently set up, but it has scarcely attracted notice. The reason for this diminution of the Finance Commission lies in the fact that the central government has converted it virtually to a departmental body entrusted with the task of imposing neo-liberal policies on unwilling state governments, by using, entirely illegally, the threat of withholding resources from them that are constitutionally their due.


Of course, even before the Finance Commissions were forced to become policemen for the central government, their importance had got undermined. This was because the centre had insisted on routing a large chunk of the total transfers it made to states through the non-FC route. The Planning Commission which is a mere departmental body of the central government, with no constitutionally-sanctified position, was one route for such transfers, viz. in the form of Plan assistance; and in addition there were discretionary transfers made at the whim of the central government. The transfers effected through the constitutionally-sanctified body, the Finance Commission, accounted for only a fraction of the total transfers from the centre to the states; and this of course enabled the centre to indulge in “favouritism”, rewarding “obedient” states and penalising “inconvenient” ones.


But at least the plan assistance, no matter how small and despite being given at usurious interest rates (the term “assistance” was indeed a misnomer), allowed the state governments to decide on their own plan priorities. Of late, however, a new entity has emerged called centrally sponsored schemes, through which not only does much of the centre’s devolution of plan resources to states take place, but which actually amount to interfering in states’ plan priorities.


State governments have to share a part of the expenditure on centrally-sponsored schemes, which have not been designed by them, and whose implementation itself is largely outside their control (often entrusted to independent bodies like the Sarva Shiksha Abhiyan, or the NRHM). States, when confronted with a CSS, are given a “take it or leave it” choice; and naturally since such schemes entail some money coming from the centre, there is pressure on them, given their straitened circumstances, to “take it”. Their own plan resources therefore get partly diverted to centrally sponsored schemes.


But that is not all. After some time, the centre decides unilaterally to lower its share of contribution to the CSS. (This unilateralism is so brazen that in the case of SSA, the centre went ahead with its proposed reduction in share despite a unanimous plea to the contrary by all the chief ministers at an NDC meet). For the continuation of the schemes therefore the state governments have to make proportionately more and more resources available. They are thus left holding schemes, over whose designing and inception they had no say whatsoever; and their own plan priorities and plan conceptions get subverted.


The NDC had decided long ago, in view of the state governments’ unanimous demand to this effect, that CSSs should be handed over, together with funds, to the state governments. But nothing has come of this decision; on the contrary the scope of such schemes has got enlarged, and the resources they absorb have increased manifold. The fact that successive Finance Commissions have turned a blind eye to this travesty of the Constitution is one reason for their diminution of status. In addition, however, the Finance Commission itself has become a tool of the central government.


The reasons for this are obvious. The centre unilaterally decides on the membership of the Commissions. It is reasonable to expect that if a body is to adjudicate between the centre and the states, then its composition should be decided not by one of the two parties unilaterally, but by both, through mutual agreement. There are plenty of institutions, such as the National Development Council, or the Inter-State Council, where both the centre and the state governments are represented; these naturally should be the fora at which the composition of the FC should be decided. But despite the fact that this demand has been put forward by the Left parties and the Left-led governments for long, the membership of the FC to this day is decided entirely by the centre, which naturally fills it with persons “acceptable” to it.


The centre also unilaterally decides on the terms of reference of the FCs. Here again, the NDC or the ISC could be used to get an agreed set of terms of reference, but this has never happened. In fixing the terms of reference, the centre also ensures that the FC, consisting of its handpicked persons as members, works on the centre’s agenda. The terms of reference of the Fourteenth Finance Commission for instance include assessing what progress the states have made in following the “road map for fiscal consolidation” suggested by the thirteenth FC and what “incentives” and “disincentives” should be used to make state governments conform to this “road map”; this in plain language means compelling the states, by withholding their resources, to practice fiscal austerity (and enact Fiscal Responsibility Legislation).




This obnoxious practice of withholding resources due to them from the states, unless they satisfied certain “conditionalities” (involving the adoption of neo-liberal measures) started with the Eleventh Finance Commission. The eleventh FC asked for a “package” of measures, which included “reforms” of State Electricity Boards (involving “unbundling” and “trifurcation”), to be adopted to the satisfaction of central government personnel, as a condition for a part of the devolved resources to be made available to them.


This was clearly un-constitutional. The Constitution was explicit that the resources made available to states by the FC were to be made available unconditionally. This is not surprising since it visualised the possibility of different state governments being ruled by different political parties with different programmes, who were electorally chosen by the people; and if this choice was to have any meaning then these different state governments should be allowed to have their different trajectories of development. Since it was neither the centre’s nor the FC’s job to tell them what development strategy to pursue, the resources being made available to them should be made available unconditionally so that they could pursue different trajectories. But the neo-liberal policy-makers decided to use the institution of the FC to ram their favoured measures down the throats of the state governments, no matter what the ideology that the political parties running these state governments subscribed to.


It must be said to the credit of Dr Amaresh Bagchi, one of the members of the eleventh  FC, that he gave a dissenting note to the FC’s report, protesting against this un-constitutional step of the Commission. What is constitutionally due to the states, he argued, must be given to them unconditionally. Even though this obnoxious and un-constitutional practice has been followed by all subsequent Finance Commissions, no other member alas has had the courage or the conviction of Dr Bagchi to voice a similar protest.


The Twelfth Finance Commission made the provision of debt relief conditional upon states passing Fiscal Responsibility Legislation which would provide for an elimination of revenue deficits and limit fiscal deficit to three per cent of the Gross State Domestic Product. This was not just un-constitutional and undemocratic, making the provision of assistance to a popularly elected government conditional upon the pursuit of specific and uniform policies which had no constitutional sanction; but it was as silly in its content, as it was shallow in its analysis of the causes of state indebtedness.


Through the decade of the nineties, states taken as a whole were better at mobilising revenue than the centre: while the ratio of the centre’s tax revenue to GDP came down over the decade, that of the states taken together did not. And yet the states taken together had a worsening debt situation over the decade. A major reason for this lay in the exorbitant rates of interest charged by the centre on the loans, including Plan assistance, it made available to states. These rates in many instances exceeded in real terms the rate of growth state GSDP, which is a sure recipe for falling into a debt-trap. Having virtually pushed the states into a debt trap, the centre then used the FC to get them to pass “Fiscal Responsibility Legislation”!


And the absurdity of such legislation lies in the fact that a lot of development expenditures undertaken by state governments, such as salaries of teachers in government and “aided” schools, salaries of doctors and costs of medicine in government hospitals, plan transfers to local bodies, are counted as revenue expenditure. Zero revenue deficit therefore would mean cutting many of these expenditures, which impinge on the lives of the common people. In short, the idea that revenue expenditure is non-developmental, which underlies the prescription for zero revenue deficit, is fundamentally wrong.




The Thirteenth Finance Commission continued with this undemocratic neo-liberal orthodoxy, through its imposition of a “road map for fiscal consolidation”. The case of Tripura illustrates its absurdity. Every state, irrespective of its size and GSDP, has to have a certain minimal administrative structure in absolute terms. When salaries of state government personnel have to increase in the wake of central pay increases, as a fall-out of Central Pay Commission recommendations, a small state has to bear a heavier burden. Instead of taking this fact into account, the thirteenth FC used arbitrary “norms” for administrative expenditure, on the basis of which it penalised states like Tripura for no fault of theirs. Instead of acting as a constitutional body, the FC had acted as neo-liberal vigilante at the behest of the centre.


The fact that successive FCs have acted in this manner is what explains the current diminished status of this constitutional body of grand conception.