The road map for the next five years for devolution of funds to the states, as recommended by the 15th Finance Commission (XVFC), is ready. Tragically though, despite the many important lessons the COVID pandemic taught us, the Finance Commission’s report seems to have largely ignored these lessons.
The draft XVFC recommendations totally ignore the aspirations of the states and their hopes of getting their due share. In fact, the structure of the recommendations has been made more discretionary in favour of the Centre, with little thought of the states’ needs, based on fairness and equity.
In fact, the report’s recommendations effectively reduce the share of the states’ incomes. Devolution of central funds on the basis of need and equity has fallen from 92.5% to 75%, with 25% of this based on efficiency and performance of the state on various fronts.
The report also attacks the federal spirit of the Constitution as, for the first time, a finance commission report finds mention of the states’ responsibility to the sovereign or national cause.
To quote from the report:
“…State finances have become a crucial lynchpin of India’s fiscal framework. Overall, as stipulated by the FRBM Act, 2003 (as amended in 2018), we believe that the States must partner with the Union Government in pursuit of medium-term consolidation of debt and firmly place India’s sovereign debt to GDP ratio on a sustainable footing in the medium term. They must partner with the Union Government in developing new ways to support the economy as a whole and India’s global engagements. Hence, the debt and fiscal trajectory of the general government envisages this partnership of both the Union and the States to achieve the key features of macroeconomic stabilisation by way of sustainable levels of debt and fiscal deficit.”
As much has already been written on this aspect, I would like to focus on the recommendations of the XVFC on urban finances. Currently, urban centres comprise nearly 34% of the population and contribute 67% of the GDP. It was expected that after witnessing the ghastly scenes of the inequity-led reverse migration of workers in the cities during the lockdown, the report would give greater emphasis to address this aspect.
However, the Commission has largely ignored this issue. Let us then see what is there in its report for the urban segment.
But before going into that, it is important to note that the two quotes mentioned in the beginning of the main report are contradictory. The first one is from Mahatma Gandhi that“the future depends on what we do in the present”. The report’s focus is thus on arguments on why present is more important.
The second quote is from the Roman philosopher Marcus Aurelius: “Never let the future disturb you. You will meet it, if you have to, with the same weapons of reason which today arm you”.
Also, while in the running commentary the report mentions the unusual times and the challenges posed by COVID, the effective part and its recommendations are the reverse of what was needed to meet the new challenges and address the people’s concerns.
Though the total outlay for the urban segment is more than what the previous finance commission had recommended, in actual terms or figures XVFC maintains the status quo.
The total outlay as per the previous commission was Rs 87,144 crore, with 15% of this not being released. Hence the actual amount spent was Rs 74,529 crore. The present commission puts the total outlay for urban local bodies for 2021-26 at Rs 1,21,055 crore. However, the 2021 outlay is lesser than that of 2020, down from Rs 25,098 crore to Rs 22,114 crore. This is 11.71% of the total grants over five years.
The criteria for grants to urban local bodies is that these will be distributed amongst states based on population and area, with 90% and 10% weightage, respectively. There are, however, two conditions for availing these grants: one, the local bodies will have to publish provisional and audited accounts and two, fixation of minimum floor rates of property taxes by states and improvement in its collection. Grants will not be released to local bodies after March 2024, if the state does not constitute a State Finance Commission and act upon its recommendations.
The XVFC categorically states:
“We recommend the provision of a one-year window for notifying the floor rates of property tax; this will trigger in two stages from 2022-23. In the first stage, States are expected to notify the floor rates and operationalise the arrangements in 2021-22. The condition of notifying the floor rates of property tax will apply for eligibility of grants from 2022-23. Once the floor rate is notified, the condition of growth in property tax collection being at least as much as the simple average growth rate of the State’s own GSDP in the most recent five years will be measured and taken into account from 2023-24 onwards.”
Another fund, called the Challenge Fund, is recommended for million-plus cities, but this will be linked to the performance of these cities in improving air quality and meeting service level benchmarks on urban drinking water supply, sanitation and solid waste management. Total allocation under this head is Rs 26,057 crores for five years.
Missing the core
The XVFC has missed the core element in the devolution of funds. As pointed out in the beginning, addressing the issue of equity and the transformation of the informal sector to almost 93% in the cities is an important challenge. Here are a few missed points:
Firstly, the devolution of a mere 11% of the total outlay of Rs 10,33,062 crore is far too meagre to meet any of the challenges cities face today. According to a high-powered committee set up by the MOUD in 2011, urban infrastructure investment requirements annually in 2013 were estimated to be Rs 50,000 crore and is expected to rise to Rs 4 lakh crore by 2032. This amounts to nearly 0.75% of the GDP in 2012-13 and will be 1.5% of GDP in 2032.
Presently, the total outlay from the XVFC and the union budget is not even 0.19% of GDP and allocation to urban local bodies is just 0.07% of GDP. In fact, the combined expenditure of urban local bodies in the country has been continuously shrinking from 1.74% of GDP in 1990 to near 1% in 2011.
The memorandum of the Ministry of Housing and Urban Affairs submitted to the XVFC sums up the requirements of the municipalities: “A substantial increase in grants is needed for bridging the resource gap of municipalities, which is anticipated at Rs. 12.27 lakh crore over the period 2021-22 to 2025-26. Devolution to municipalities may be increased by at least four times (to Rs. 3,48,575 crore), as compared to the FC-XIV award.”
Secondly, it is important that the constant harping over collection of property tax and linking it to availing Central grants must be dropped. No doubt, property tax is an important source of resource mobilisation for municipalities. But to over centralise it would be erroneous.
The provision for asking state governments to decide the floor area rate for property tax too is completely flawed. Every town and city has a different capacity and even intra-city there are differences in property appreciation. This task must be left to the municipalities and not to the state governments. In fact, best practices must be followed to ensure collection of property tax.
Besides, the previous year has been a year of disaster for individuals and a large number of businesses. A better option would have been a complete waiver of property taxes, especially from the hospitality industry, and provision of a grant in its place.
Thirdly, the same past mistake of considering cities to be the main engines of growth continue to plague the XVFC. Since the UN Habitat III, there has been a concerted effort to focus on sustainability goals and not to treat cities as market entrepreneurs. We have seen how unsustainable our cities have become with humongous inequity spreading rampantly.
The effort should have been to check this trend. Unfortunately, the recommendations continue with the same old jargon and intent. Take for example the language of the document: “creating model PPP contracts, modernising municipal budgeting, evolving national municipal borrowing framework including provisions equivalent to the Fiscal Responsibility and Budget Management Act for urban local bodies,” all of which point to the same mindset of converting cities into attractive investment zones.
Not realising the fact that nearly 90% of urban local bodies are unable to even meet their salary expenditures, such recommendations make absolutely no sense. Further, the XVFC did not pay any heed to inequity widening in the cities.
Fourthly, in such a situation, the XVFC was expected to create a separate fund for an urban employment guarantee scheme or something similar to address the acute unemployment existing in the cities, akin to what it has recommended on pollution and air quality.
Which is one of the main expectations that the Commission has completely belied.
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