Model Answer

Role of State Finance Commissions (SFCs) in Empowering Local Governments in India

State Finance Commissions (SFCs), created under Articles 243(1) and 243(Y) of the Indian Constitution, play a crucial role in empowering local governments by addressing fiscal imbalances and ensuring financial decentralization. Their primary functions include:

• Devolution of Finances: SFCs recommend how state tax revenues should be shared between the state and local bodies, ensuring equitable distribution across different tiers of local government (Panchayats and Urban Local Bodies or ULBs).
• Financial Powers: They recommend taxes, duties, and fees that local bodies can levy to enhance their financial autonomy.
• Grants-in-Aid: SFCs determine the amount of grants to be allocated to local bodies from the state’s Consolidated Fund.
• Fiscal Strengthening: They assess and suggest measures to improve the financial health of local governments, promoting their long-term sustainability.
• State Financial Assessment: SFCs evaluate the financial status of the state and suggest necessary restructuring measures to ensure efficient fiscal management at the local level.

Reforms Needed to Enhance the Effectiveness of SFCs

Despite their importance, several challenges hinder the effectiveness of SFCs:

• Delayed Constitution of SFCs: Many states fail to form SFCs on time, with only 9 states constituting their 6th SFC and another 7 their 5th in 2022. Such delays disrupt the timely transfer of resources and affect local governance (Source: Union Finance Commission).
• Data Deficiency: The lack of reliable data significantly hampers the work of SFCs, as they must start from scratch with each new commission, affecting the accuracy and timeliness of their recommendations.
• Delay in Reports and Action Taken: SFCs often take over 30 months to submit their reports, leading to delays in implementing their recommendations and ineffective fiscal planning.
• Inconsistent Resource Distribution: There is a lack of uniformity in how resources are allocated between states and local bodies, leading to inequities in devolution (vertical and horizontal).
• Implementation Gaps: Even when SFC recommendations are accepted, states often fail to implement them, limiting their potential impact on local governance.

To enhance the effectiveness of SFCs, reforms such as timely constitution of commissions, better data systems, and stronger political will for implementation are essential. Adherence to constitutional mandates will ensure that local bodies become more financially autonomous and capable of fulfilling their governance roles.

Model Answer

Introduction

Recently, several states have protested against what they perceive as fiscal discrimination by the Centre, even approaching the Supreme Court of India. While the measures taken by the Central government have certainly impacted state finances, it is essential to examine the financial challenges faced by state governments and the role they play in this situation.

Central Government Measures Impacting State Finances

Increase in Cesses and Surcharges
The Central government has increased the share of cesses and surcharges, effectively reducing the amount of tax revenue available to states. For instance, the share of cesses and surcharges in the Centre’s gross revenue increased from 8.6% in 2010-11 to 28% in 2021-22, which has diminished the divisible pool for states.

Decline in Centrally Sponsored Schemes (CSS)
The reduction in Centrally Sponsored Schemes from 130 to 70 starting in April 2023 has placed additional financial burdens on states. The reduction has limited central assistance, making it harder for states to finance key projects.

Restricting Borrowing by States
The Centre has reduced the fiscal space available to states by including their off-budget borrowings in the Net Borrowing Ceiling (NBC). For example, Kerala challenged this move in the Supreme Court, arguing that it severely restricted their ability to manage state finances.

State Governments’ Role in Financial Challenges

Power Sector Issues
State governments often cover the losses of power companies with grants or guarantees against their borrowings, which increases their contingent liabilities. For example, nearly 40% of loans raised by state-owned entities are guaranteed by state governments.

Non-merit Freebies
Several states have allocated substantial funds for non-merit freebies, such as loan waivers and subsidies, which strain their fiscal capacity. States like Punjab have been identified as being on the brink of a fiscal crisis due to these subsidies.

Reintroduction of Old Pension Scheme (OPS)
Some states, including Rajasthan and Punjab, have reinstated the OPS, which places a significant future burden on state finances and limits capital expenditures.

Excessive Borrowings
States like Tamil Nadu have consistently borrowed to fund welfare schemes, leading to rising debt levels. Tamil Nadu, for example, has been the top borrower in the country for the past four years.

Conclusion

While central measures have certainly affected state finances, the states themselves also need to address their financial management issues. A balanced approach that enhances states’ revenue-generating capabilities and ensures timely transfers from the Centre is necessary for tackling the looming fiscal challenges.