Charting the path for the Sixteenth Finance Commission

Context

The upcoming Sixteenth Finance Commission faces several challenges due to critical changes since the formation of the Fifteenth Finance Commission, including the impact of COVID-19 and geopolitical issues. The government debt-GDP ratio has surged to around 90% by the end of 2020-21, and many states are grappling with significant fiscal imbalances.

The vertical and horizontal dimensions

State’s share: The Fourteenth Finance Commission increased the share of States in central taxes to 42% (later revised to 41% for 28 States) but further increases may not be recommended due to the Centre's fiscal imbalances.
Setting upper limit: The 16^th Finance Commission should scrutinize the heavy reliance on cesses and surcharges (18.5% of Centre's GTR) and consider setting an upper limit for these components, with an increase in States' share if exceeded.
Addressing lower income states: While some States argue for reducing the weight given to per capita income as a determining factor for shares, attention must be given to the needs of lower income States.

Recommendation

Above norms: The combined debt-GDP ratio of central and State governments peaked at 89.8% in 2020-21, well above the corresponding FRBM norms of 40% and 20% respectively. The fiscal deficit for the Centre was 9.2% of GDP, and for States, it was 4.1%, further deviating from the norms.
Re-examination: The 2018 amendment to the Centre's FRBM needs to be re-examined in light of the significant departures from debt and fiscal deficit to GDP ratios and the reduction of States' debt-GDP target to 20%.
Concerns: Concerns are raised about certain State governments having higher debt and fiscal deficit numbers relative to their GSDPs, often leading to increased fiscal deficits.

Reforms worth pursuing

Establish an independent loan council: To oversee loan magnitudes and profiles of central and State governments, as recommended by the 12^th Finance Commission.
Examine non-merit subsidies: Excluding 'unjustified' subsidies to avoid political controversies in grant determination.
State’s limits: Be strict about States adhering to fiscal deficit limits, offering rewards for compliant States, and penalties for those exceeding limits by controlling borrowing.

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