India's twelfth finance commission : a view from Kerala

The focus of the paper is to review the Terms of Reference (TOR) of the Twelfth Finance Commission with special reference to Kerala. It also critically examines the emphasis on fiscal deficit reduction without paying attention to its quality and finds that this has led to the Centre and the States resorting to a softer option of cutting productive capital and necessary maintenance and social sector expenditure. This is likely to have adverse consequences on equitable growth and to impede the process of relieving the economy of structural constraints on growth. There is an urgent need for analysing the quality of fiscal consolidation instead of focusing merely on quantity of reduction of deficits as a proportion of Gross Domestic Product (GDP). The study hence suggests incorporating the concept of Quality of Fiscal Discipline. It is found that there has been an enlargement of the scope of Finance Commissions [since the Eleventh Finance Commission (11th FC)] into mandates for recommending mechanisms for achieving macroeconomic balance, equitable growth, and suggestions for disinvestments and privatisation, while its role in the traditional area of grant devolution has been restricted to non-Plan grants only. In fact, the enlargement of the role in the traditional area of grant devolution would be more desirable. There is sufficient scope for augmenting resource mobilisation from direct and indirect taxes at the Central level. Emphasis is to be placed on integrating services and manufacturing into a single CENVAT (Central Value Added Tax) and on direct taxes reform. The second generation tax reform should concentrate on States’ tax administration and inter-State coordination prior to moving on to a State level VAT. There is need for a constitutional amendment to place service tataxation in the Concurrent List and enable States to tax more services. On the expenditure side, steep increases in items like wages and salaries and interest expenditure are unlikely in the near future. Hence maintenance and social sector expenditure should not be sacrificed. At the same time, efficiency in spending and cutting unproductive expenditure and leakages should be strictly monitored. A decentralised district level monitoring system for maintenance expenditure of capital assets is also suggested. The paper argues that bringing privatisation in the Terms of Reference of the Finance Commission seems avoidable. It is also felt that more effective time bound implementation of State Finance Commission Reports is needed. Along with devolution of funds, transfer of administrative functions is necessary for avoiding duplication of expenditure. As for Kerala-specific issues, it is found that achievements on the human development front are not rewarded. Certain changes in the existing criteria (of the Eleventh Finance Commission) are hence suggested. Kerala’s tax effort, though better than richer States like Punjab, is facing structural constraints. The fast expanding services sector is outside the tax net of the State. The tax-GDP ratio of Kerala showed a mild decline at 9.84 percent in the 1990s as compared to 10.29 percent in the 1980s despite a much higher growth rate of State Domestic Product, mainly because the State was not able to tax the dominant sector of the State Domestic Product, that is, the services sector. Key words : finance commission, fiscal deficit, revenue mobilisation, devolution JEL Classification : H77, H60, H20