Analyse the relevance of Gadgil formula in reducing horizontal imbalance of fiscal health.

Understanding the Gadgil Formula

The Gadgil formula, initially designed for a 10-year period (1995-2005), aimed to determine the share of states in the divisible pool of central taxes. It assigned weights to various criteria, reflecting the fiscal needs and performance of states. The key criteria and their initial weights were:

• Population (20%): Reflecting the basic need for resources based on population size.
• Fiscal Capacity (59%): Measured by the per capita income, indicating the state’s ability to generate its own revenue. This was the most heavily weighted criterion.
• Fiscal Discipline (10%): Assessing the state’s ability to manage its finances responsibly, measured by revenue deficits.
• Demographic Performance (11%): Considering the state’s progress in controlling population growth.

Relevance in Reducing Horizontal Imbalance

The Gadgil formula was relevant in several ways:

• Addressing Fiscal Needs: By incorporating population and demographic performance, the formula acknowledged the specific needs of states with larger populations or those struggling with demographic challenges.
• Correcting for Fiscal Capacity: The high weightage given to fiscal capacity ensured that states with lower per capita incomes received a larger share of central taxes, helping to bridge the gap with wealthier states.
• Incentivizing Fiscal Discipline: The inclusion of fiscal discipline as a criterion encouraged states to maintain sound financial management practices.

Evolution and Modifications

The formula underwent modifications by subsequent Finance Commissions. The Eleventh Finance Commission (2000-2005) retained the core structure but adjusted the weights. The Thirteenth Finance Commission (2005-2010) introduced a distance criterion to address the needs of states lagging behind the national average in per capita income. The Fourteenth Finance Commission (2015-2020) significantly increased the states’ share in the divisible pool of central taxes from 32% to 42%, largely based on the 2011 population census. This shift, while increasing overall devolution, also led to concerns about exacerbating horizontal imbalances as it relied heavily on population.

Criticisms and Limitations

Despite its relevance, the Gadgil formula faced criticisms:

• Data Reliability: The accuracy of data used to calculate fiscal capacity (per capita income) was often questioned.
• Incentive Issues: Some argued that the formula did not adequately incentivize states to improve their own revenue mobilization efforts.
• Population Bias: The increased reliance on population in later revisions, particularly by the Fourteenth Finance Commission, was criticized for potentially disadvantaging better-performing states with lower population densities.
• Lack of Dynamic Adjustment: The formula was criticized for being relatively static and not fully responsive to changing economic conditions and state-specific needs.

Current Relevance

The Gadgil formula, in its original form, is no longer directly used. However, its underlying principles of addressing fiscal needs, correcting for fiscal capacity, and incentivizing fiscal discipline continue to inform the approach of subsequent Finance Commissions. The Fifteenth Finance Commission (2020-2026) has adopted a multi-criteria approach, incorporating factors like income distance, demographic performance, forest and ecology, and tax and fiscal efforts. The debate on the optimal weights for these criteria, and the balance between equity and efficiency, remains central to ensuring a fair and effective devolution of resources to states.