Model Answer
0 min readIntroduction
Fiscal federalism, at its core, refers to the financial relationship between different levels of government – the Union, States, and local bodies – within a federal structure. It encompasses the division of financial powers, resource allocation, and mechanisms for fiscal equalization. The Twelfth Finance Commission (2005-2010), chaired by C. Rangarajan, was tasked with recommending a fiscal roadmap for the five years following the Eleventh Finance Commission. Its recommendations were particularly significant as they came amidst growing concerns about the fiscal health of several states and the need for a more equitable and efficient system of resource transfer. This answer will critically analyze the TFC’s key recommendations on fiscal federalism, evaluating their impact and limitations.
Key Recommendations of the Twelfth Finance Commission
The TFC made several significant recommendations impacting fiscal federalism in India. These can be broadly categorized into tax devolution, grants-in-aid, debt relief, and strengthening local body finances.
1. Tax Devolution
The TFC recommended a devolution of 30.5% of the divisible pool of central taxes to the states, a substantial increase from the 29.5% recommended by the Eleventh Finance Commission. This increase aimed to provide states with greater fiscal autonomy and resources to address their developmental needs. The Commission also emphasized the need for greater transparency and predictability in the devolution process. It advocated for using a composite index comprising demographic performance, fiscal discipline, and economic efficiency as criteria for determining the states’ share.
2. Grants-in-Aid
The TFC categorized grants-in-aid into two types: specific-purpose grants and general-purpose grants. It recommended a significant increase in general-purpose grants to states, allowing them greater flexibility in utilizing the funds based on their specific priorities. Specific-purpose grants were linked to specific schemes and programs of the central government. The Commission also proposed a new category of grants – performance-linked grants – to incentivize states to improve their performance in areas such as health, education, and infrastructure.
3. Debt Relief
Recognizing the precarious debt situation of several states, the TFC recommended a debt relief package. It proposed restructuring the debt of states, including converting a portion of their loans into grants and extending the repayment period. This was intended to alleviate the debt burden on states and create fiscal space for developmental expenditure. The Commission also emphasized the need for states to adopt prudent debt management practices.
4. Strengthening Local Body Finances
The TFC strongly advocated for strengthening the finances of local bodies – Panchayati Raj Institutions (PRIs) and Urban Local Bodies (ULBs). It recommended increasing the share of central funds allocated to local bodies through state finance commissions. It also suggested measures to enhance the revenue-generating capacity of local bodies, such as allowing them to levy property taxes and user charges. The Commission emphasized the importance of capacity building of local bodies to ensure effective utilization of funds.
Critical Analysis
Strengths of the Recommendations
- Increased Fiscal Autonomy: The higher tax devolution percentage provided states with greater financial autonomy and flexibility.
- Focus on Equity: The emphasis on a composite index for determining states’ share aimed to address horizontal fiscal imbalances and promote equity.
- Debt Relief Measures: The debt relief package provided much-needed respite to states burdened by high debt levels.
- Strengthening Local Bodies: The recommendations for strengthening local body finances were crucial for promoting decentralized governance and local development.
Weaknesses and Limitations
- Conditionalities Attached to Grants: While general-purpose grants were beneficial, the significant proportion of specific-purpose grants with stringent conditions limited states’ flexibility.
- Implementation Challenges: The implementation of the TFC’s recommendations faced challenges, particularly regarding debt restructuring and the effective utilization of funds by local bodies.
- Limited Impact on Fiscal Discipline: Despite recommendations for fiscal discipline, several states continued to exhibit fiscal imbalances.
- Criteria for Devolution: The composite index used for determining states’ share was criticized for being complex and potentially biased.
Impact on Centre-State Relations
The TFC’s recommendations generally fostered a more cooperative relationship between the Centre and the states. The increased tax devolution and debt relief measures were welcomed by most states. However, disagreements arose over the conditions attached to grants and the criteria for determining states’ share. The implementation of the recommendations also highlighted the need for greater coordination and collaboration between the Centre and the states.
| Aspect | Eleventh Finance Commission (2000-2005) | Twelfth Finance Commission (2005-2010) |
|---|---|---|
| Tax Devolution (%) | 29.5% | 30.5% |
| Emphasis on Grants | Higher proportion of specific-purpose grants | Increased general-purpose grants & performance-linked grants |
| Debt Relief | Limited debt relief measures | Significant debt restructuring package |
| Local Body Finances | Focus on strengthening State Finance Commissions | Increased share of central funds to local bodies; capacity building emphasis |
Conclusion
The Twelfth Finance Commission played a pivotal role in shaping fiscal federalism in India. Its recommendations, particularly regarding increased tax devolution and debt relief, contributed to greater fiscal autonomy for states and improved their financial health. However, the implementation challenges and limitations related to conditionalities and criteria for devolution highlighted the need for continuous refinement of the fiscal transfer system. The TFC’s legacy lies in its emphasis on equity, fiscal discipline, and strengthening local governance, providing a foundation for subsequent Finance Commissions to build upon. Future commissions should focus on streamlining the grant system, enhancing transparency, and promoting greater accountability in the utilization of funds.
Answer Length
This is a comprehensive model answer for learning purposes and may exceed the word limit. In the exam, always adhere to the prescribed word count.