Crafting Karnataka’s fiscal pitch to the Finance Commission

The Sixteenth Finance Commission is due to be constituted this year. As reported in many periodicals, the Union government is preparing to set it up early so that the Finance Commission gets sufficient time to deal with the issues and suggest recommendations.

Article 280 of the Constitution refers to the formation, role and responsibility of the Finance Commission. As per this Article, the President shall, within two years from the commencement of this Constitution, and thereafter at the expiration of every fifth year or at such earlier time as the President considers necessary, by order, constitute a Finance Commission that shall consist of a chairman and four other members to be appointed by the President.

The commission shall submit its recommendations for: (i) the distribution between the Union and the states of the net proceeds of taxes that are to be, or may be, divided between them and the allocation between the states of the respective shares of such proceeds; (ii) measures needed to augment the consolidated fund of a state to supplement the resources of the panchayats and municipalities and (iii) any other matters referred by the President in the interest of sound finance.

Basically, the Finance Commission recommendations are to ensure the vertical and horizontal balance (or reduce imbalance) between the Centre and state finances. The vertical balance refers to the share of financial resources between the Union government and state governments and the horizontal balance refers to the distribution of the share between states.

The Finance Commission recommends the share of states in the divisible pool. The divisible pool consists of all taxes, except surcharges and cess levied for a specific purpose, and net of collection charges.

Previously many of the states argued to include cesses in the divisible pool so that they get more resources. The Fourteenth Finance Commission recommended raising the share of states in the divisible pool to 42%, which was 32% during the Thirteenth Finance Commission period. The Fifteenth Finance Commission (FFC) recommended a 41% share to states from the divisible pool.

Earlier, the Terms of Reference (ToR) of the FFC raised many debates. Many of the states, particularly the southern states, opposed the ToR for considering the 2011 census population in place of the 1971 census population by the FFC. Because these states have achieved a replacement level of fertility, if the 2011 census population is considered, their share will be reduced. Notably, it did affect their share.

Karnataka faced a severe decline in its share in the divisible pool from 4.713% during the Fourteenth Finance Commission to 3.65% in the FFC period. Budget 2023-24 (July 2023) of Karnataka highlighted that the state incurred a loss of Rs 26,140 crore in the past three years and Rs 10,858 crore in 2023-24 itself.

The impact of Covid-19 on the state’s own revenue, the discontinuation of GST compensation since July 2022, increased committed expenditure etc have further worsened the fiscal situation of Karnataka. Fulfilling the poll promise of providing the five guarantees is also adding to the fiscal stress. Given these circumstances, the government has to pause or extend the ceilings set under the Karnataka Fiscal Responsibility Act, 2002.

Once the next Finance Commission is set up, all state governments shall submit their memorandums highlighting the current fiscal situation as well as resource requirements. The Karnataka government may consider the following points while preparing its memorandum.

First, Karnataka should argue for considering the 1971 population or giving more weightage for achieving a replacement level of fertility and other demographic achievements. The state should highlight all the policy measures undertaken to progress in the demographic indicators.

Second, Karnataka is known for fiscal discipline. It is the first state in India to enact a rule-based fiscal correction mechanism and adhere to it. Except for a few years owing to the financial crisis during 2008 and the Covid-19 effect from 2020-21 to 2022-23, Karnataka was on the right path of fiscal consolidation.

The state is also performing well in terms of tax efforts and tax buoyancy. Consideration of fiscal discipline as an indicator by the Finance Commission shall benefit the state and it will serve as an incentive
not only for Karnataka but also to other states, which are following the fiscal consolidation roadmap.

Third, the state should also highlight its contribution toward GST collections and key initiatives, particularly the e-initiatives taken by the Karnataka government, to increase tax mobilisation.

The revenue gap arising out of discontinuing the GST compensation cess should be underlined. Fourth, the committed expenditure of the state has increased over the years and crossed 100% of revenue receipts. The state is having post-devolution revenue deficits and should demand for grants to fill this gap.

Fifth, the agriculture sector in Karnataka is mainly dependent on the monsoon. To maintain sustainable employment
and agricultural output generation, more investments are needed to provide irrigation facilities.

Sixth, urban agglomeration is becoming a major challenge in India and, particularly, in Karnataka. Cities in Karnataka are growing at a much faster rate. Financing the needs of Bengaluru itself is a big challenge for the government.

Providing basic facilities requires continuous attention and resources. Reports of Bengaluru’s flooded roads during the rainy season, traffic congestion, solid waste management, increasing pollution levels and others are almost regular these days.

The Sustainable Development Goal (SDG) number 6 (clean water and sanitation) and number 11 (sustainable cities and communities) are the priority SDGs for Karnataka, where it is ranked lower. These challenges and financial requirements to tackle these problems should be emphasised.

Finally, financing SDGs is a challenge to all states, including Karnataka. The Karnataka government has come up with the ‘Aspirational Taluks Programme’ and is prioritising the development of the Kalyana Karnataka region so that it enables faster achievement of SDGs by 2030. The memorandum should accentuate the achievements so far and the financial requirements to attain the SDGs by 2030.

Let us hope that Karnataka’s fiscal discipline, barring a few years, its tax efforts and financing needs are considered and rewarded by the upcoming Finance Commission.  

(The writer is an assistant professor at the School of Social Sciences, Ramaiah University of Applied Sciences, Bengaluru)