Syllabus
GS Paper 3 – Indian Economy – Issues relating to mobilisation of resources.
Context
The Government of Tamil Nadu recently hosted the Sixteenth Finance Commission, chaired by Arvind Panagariya
Source
The Hindu| Editorial dated 6th December 2024
States and the challenge before the Finance Commission
Finance Commission aims to rectify the skewed financial relationship between the States and the Union, and its decisions will significantly shape the fiscal landscape for the next five years and influence the country’s economic trajectory in the coming decades. As global economic trends shift, the Commission faces the challenge of balancing equitable resource distribution with incentivizing growth in high-performing regions, such as South Indian states.
Opportunities from Global Economic Changes
- Emerging Global Trade Patterns:
- Friendshoring and reshoring are reshaping global trade, presenting India with new opportunities.
- India, particularly South Indian states, can leverage these shifts in trade and investment patterns to bolster economic growth.
- The Sixteenth Finance Commission must align fiscal policy to harness these opportunities while maintaining an equitable distribution of resources.
- Balancing Redistribution and Growth Incentives:
- The Commission needs to strike a balance between providing equitable redistribution of resources to less-developed states and incentivizing higher-performing regions, like South Indian states.
- While growth in high-performing states can contribute to national economic progress, the Commission must ensure that these states do not face a disproportionate financial burden due to under-devolution.
- Impact on National Economic Trajectory:
- The fiscal decisions of the Finance Commission will shape India’s economic trajectory for decades, influencing national policies and strategies for growth.
- By addressing issues such as resource distribution and fiscal autonomy, the Commission will play a critical role in defining India’s position in the global economy.
- Adaptation to Global Trends:
- As global economic trends evolve, India’s fiscal policy must adapt to remain competitive.
- The Sixteenth Finance Commission’s decisions will be pivotal in ensuring that India capitalizes on these global changes without losing sight of regional disparities in economic growth.
Vertical Devolution and Resource Allocation
- Inequities in Previous Finance Commissions:
- The Fifteenth Finance Commission allocated 41% of the divisible pool to states, but the actual devolution was only 33.16%, a significant shortfall.
- Cess and surcharges levied by the Union Government contributed to the reduced effective devolution, highlighting systemic issues in fiscal distribution.
- Increased Share for States:
- To ensure financial autonomy, it is recommended that the vertical share of gross central taxes be increased to 50% for states.
- This increase will allow states to implement locally relevant welfare and development schemes without excessive dependency on the Union.
- Fiscal Autonomy and Development:
- Granting states greater fiscal autonomy will enable them to address local developmental challenges more effectively.
- South Indian states, for example, could utilize this increased share to address specific challenges such as urbanization and demographic shifts.
- Moving Beyond Systemic Corruption:
- The introduction of Direct Benefit Transfers (DBT) has reduced the role of middlemen, improving the efficiency of resource distribution.
- The Finance Commission must build upon this model to ensure resources reach beneficiaries directly, reducing wastage and corruption.
Horizontal Devolution and Performance-Based Distribution
- Limited Success of Horizontal Devolution:
- For over four decades, the horizontal devolution policy has not been very effective in driving growth.
- The redistribution approach has failed to create substantial economic growth in less-developed states, calling for a revision of the strategy.
- Reevaluating Resource Allocation:
- The focus should shift towards a more balanced approach, aiming to grow a larger national economic pie rather than solely redistributing a smaller one.
- The Finance Commission should design resource allocation strategies that provide reasonable resources for less-developed states, while also ensuring that high-performing states like South Indian states continue to thrive.
- Performance Incentives for High-Growth States:
- A progressive approach should be adopted, where performing states are rewarded with higher allocations based on their contribution to the national economy.
- South Indian states, which are key economic drivers, should receive appropriate incentives to maintain their upward growth trajectory.
- Strengthening Growth Engines:
- High-performing states should be empowered to play a larger role in the national economy by addressing their unique challenges.
- The Commission should consider the specific needs of these states, ensuring that their development is not stunted by insufficient resource allocation.
Unique Challenges in Progressive States
- Demographic Shifts and Aging Population:
- South Indian states, particularly Tamil Nadu, face challenges related to an aging population, which reduces the capacity to generate consumption-based tax revenue.
- The rising costs of supporting an aging population require special financial considerations, and the Commission must address these concerns in its fiscal framework.
- Urbanization and Infrastructure Needs:
- South Indian states, especially Tamil Nadu, are witnessing the fastest urbanization in India, with a projected urban population of 57.30% by 2031, significantly higher than the national average of 37.90%.
- The Finance Commission must allocate resources to address the infrastructure needs of urbanization, including housing, transportation, and basic services.
- Preventing the Middle-Income Trap:
- States like Tamil Nadu risk falling into the middle-income trap, where growth stagnates before they can reach high-income status.
- The Commission must ensure that these states have the resources necessary to avoid this trap, particularly through investments in infrastructure, innovation, and human capital.
- Long-Term Sustainability of Growth:
- The Commission must ensure that South Indian states are not left behind in terms of funding for sustainable growth.
- Climate resilience and adaptation strategies for the challenges posed by urbanization and demographic changes must be integrated into the fiscal planning process.
Conclusion
It is crucial that the Commission strikes a balance between equitable resource distribution and incentivizing growth in progressive states like South Indian states. Addressing the unique challenges of demographic shifts, urbanization, and fiscal autonomy, while ensuring that less-developed states are not left behind, will be key to India’s success. By doing so, the Commission can help India achieve sustainable, inclusive growth and strengthen its position on the global stage.
Related PYQ
How have the recommendations of the 14th Finance Commission of India enabled the States to improve their fiscal position? [ UPSC Civil Services Exam – Mains 2021]
Practice Question
Critically examine the role of the Finance Commission in promoting fiscal federalism in India and discuss the challenges it faces in ensuring equitable resource distribution among states. [150 words]
Guidelines for Answering the Question
- Introduction:
- Define the Finance Commission and its role in fiscal federalism in India.
- Body:
- Discuss how the Finance Commission recommends the distribution of central taxes between the Union and the States.
- Mention challenges Faced by the Finance Commission
- Acknowledge specific Issues in Resource Distribution
- Conclusion:
- Conclude by stressing the need for the Finance Commission to evolve with the times to ensure a fair and dynamic fiscal structure for India’s federal system.