State’s Finance Vs Centre’s Finances in times of Pandemic

Relevance: GS-3: Indian Economy and issues relating to Planning, Mobilization of Resources, Growth, Development and Employment.

Key Phrases: Fiscal deficit, GST compensation cess, Fiscal federalism

Why in news?

There is a clear divergence in the fiscal trends of the Government of India (GoI) and state governments

The double whammy (also termed as scissor effect) of the Covid-19 pandemic — a collapse in revenue and rise in health-related and other costs — is likely to have a significant impact on state government finances.
Average value of gross fiscal deficit to GSDP for the states which presented their budget before the outbreak of the pandemic is 2.4%, while the average for the remaining states that made post-outbreak budget presentations is 4.6%
Combined revenue deficit of the state governments rose from 0.1% of GDP in 2018-19 to 2% of GDP in 2020-21 because of the pandemic

Centre’s fiscal deficit stood at Rs 5.5 trillion in April-October 2021, down from the Rs 7.2 trillion pre-pandemic level (April-October 2019), with incremental revenues outpacing expenditure.
Despite the likely revenue foregone from the excise and customs duty relief, we expect the Centre’s net revenue receipts to exceed the budget estimate by Rs 1.7 trillion led by a robust performance of direct taxes and GST,
Central transfers to states fell by Rs 0.9 trillion, with the decline split almost equally between grants and tax devolution

Indian Constitution has provisions relating to:
- the distribution of the taxes as well as non-tax revenues
- the power of borrowing
- grants-in-aid by the Union to the States
Article 268 to 293 deals with the provisions of financial relations between Centre and States.
The Parliament has exclusive power to levy taxes on subjects enumerated in the Union List.
The state legislature has exclusive power to levy taxes on subjects enumerated in the State List.
Both can levy taxes on the subjects enumerated in Concurrent List whereas residuary power of taxation lies with Parliament only.

Various cess and surcharges, in which States’ have no share, are becoming a disproportionate portion of overall divisible revenue. This is against the spirit of fiscal federalism and financial devolution process-increased from 9% to 15% from 2014 of gross tax revenue
States have constraints in managing their finances as the RBI controls their deficit and cannot float a bond on a state’s behalf without the Centre’s approval – debt to GDP ratio rose to 25% as 22% in 2015
With the advent of GST framework, revenue autonomy of states has shrunk considerably as states have lost decision making power on tax rates. Also, there is a greater unpredictability associated with transfers of IGST and grants
Since 2020-21, a portion of the GST compensation is being financed through back-to-back loans from the Centre, which enters state accounts as a financing item

Fiscal consolidation through strengthening tax buoyancy rather than compressing public expenditure should be the approach
Make central transfers more effective: Well-defined calendars for transfer; compositional shift from tied to untied transfers and reducing the levy of cess & surcharges, which are outside the divisible pool
States have to be given more sources for tax collection or discontent will keep rising due to cross subsidy which is not going to go away anytime soon
Reliance on centrally sponsored schemes should be reduced while tax devolution and grant in aids should be primary source of transfer
Panchayats and municipalities should be devolved powers as given in 11th and 12th schedule