Revisit devolution methodology now

The 16th Finance Commission should refine income distance criteria to mitigate metro cities’ impact on per capita income.

Successive Finance Commissions (FCs), including the last one (15th FC), have accorded highest weightage to what is known as the income distance (ID) criteria for determining each state’s share in the Centre’s divisible tax revenue pool. The 15th FC assigned 45 per cent weightage to ID, together with significant modifications in the application of the population criterion.

In combination, they effectively weakened the role of the secondary criteria of fiscal performance and population stabilisation record of states in the final determination of the devolution share. Thus, when the award of the 15th FC became operational in 2021, many states were left unhappy.

Karnataka was perhaps the most notable case among the unhappy states. The FC should have treated its Karnataka award as an anomalous case warranting corrective intervention. That didn’t happen. The state lost significantly as its devolution share fell the sharpest of all states. A drop of 1.066 percentage points over its share under the 14th FC, from 4.713% to 3.647%.

To place the anomaly in perspective, it is relevant to consider other states that are broadly identified in the same category as Karnataka regarding revenue-generation and economic growth trends.

These states are: Maharashtra, Tamil Nadu, Gujarat, Haryana, Telangana, Andhra Pradesh and Kerala. Barring Telangana and AP, the devolution share of these states in the 15th FC actually increased. The share of Telangana and Andhra Pradesh dropped rather marginally by 0.335 and 0.258 percentage point, respectively.

Worse yet for Karnataka, in the 15th FC’s own estimates, among the eight states in the group, it was the only one to receive less devolved funds in absolute terms during the 5-year implementation period compared with what was awarded to it by the 14th FC.

Every other state received at least a token increase in absolute terms. The 15th FC estimated that Karnataka would receive Rs 18,890 crore less than what it had received during the five-year award period of the 14th FC. Should this really be an intended outcome of a devolution award? We have no doubt it was a case of anomaly.  

Karnataka’s case calls for innovative approaches. The 16th FC under Arvind Panagariya should consider refining the devolution methodology. 

We believe that the best starting point is to explore innovative approaches to calculating ID. The per capita income (PCI) figures currently used for the devolution purpose do not fairly reflect each state’s socio-economic situation.

We witness spatially uneven growth and income disparities within states. Therefore, the standard PCI figures provided for the states do not necessarily reflect ground realities. The PCI distortions are significant in states home to large urban economic centres. These centres are largely islands of prosperity in an ocean of relative deprivation.

To illustrate, our top 10 metros are estimated to account for over 25% of the country’s GDP. Furthermore, over a period of 7 years up to 2023-24, the gross direct tax and GST collections in just two states of Maharashtra and Karnataka (read Mumbai and Bengaluru, mainly) made up 40% of the entire national level collections!

Consider the official PCI figures (2022-23) for 5 of the 8 states mentioned above: it is Rs 3,11,649 for Telangana (the highest for all states in the country), Rs 3,04,474 for Karnataka, Rs 2,95,787 for Kerala, Rs 2,89,415 for Maharashtra, and Rs 2,75,583 for Tamil Nadu. These are comparatively impressive figures in the overall national context. Significantly, barring Kerala, the other four states are home to six of the top 10 ten metros in the country. 

But when we exclude the top metro centre in each state (Bengaluru, Mumbai, Hyderabad, Chennai and Kochi/Ernakulam) as we recalculate PCI for the states, we arrive at a surprisingly transformed picture.

Look at the revised PCI figures for each state without their respective top metros: Telangana Rs 2,31,726 (-25.65%), Karnataka Rs 2,23,039 (-26.75%), Kerala Rs 2,84,774 (-3.72%), Maharashtra Rs 2,45,505 (-15.17%), and Tamil Nadu Rs 2,27,906 (-17.30%).

From 2nd position in the formal PCI ranking among the 5 states, Karnataka drops to the bottom of the revised table, with Kerala climbing to the top.

The revised PCI figures leave Karnataka, Telangana, Tamil Nadu, and Maharashtra significantly behind. These figures reflect the economic conditions in these states more realistically. The metros massively inflate state’s PCI. If we exclude Bengaluru, Karnataka’s PCI falls the sharpest, by 26.75%. It accounts for over 35% of the state’s GSDP, whereas 80% of its population lives outside the city where economic conditions are vastly different. 

Interestingly, Kerala emerges as the new PCI leader, reflecting the merit of this innovative approach. The state is the acknowledged topper of national charts in terms of diverse development indicators and it enjoys an overall higher standard of living.

The fact that this approach yields a more realistic PCI figure that better reflects the socio-economic ground realities, even in the so-called revenue-rich, makes a strong case for its consideration by the FC while applying the ID criteria for the devolution purpose.

As a measure of fairness, it could consider excluding the leading urban district in each state for arriving at realistic PCIs. This should probably also help arrive at a fairer devolution share for each state. It is also imperative for the FC to address the dire financial state of the top metros that are undoubtedly the proverbial goose laying golden eggs for the Centre’s revenue kitty.

(The writer is a senior journalist)

Disclaimer: The views expressed above are the author's own. They do not necessarily reflect the views of DH.