Thread by @pranaykotas

Quite amusing that the north-south debate over public finances has been taking place with complete disregard to Public Finance theory itself. Guess it shouldn't be surprising but let me attempt anyways.. #thread

First of all, I'm no expert in the subject. Much of what I know comes from a few textbooks and by listening to Gurus like Dr M Govinda Rao. All mistakes are my own and I'll be happy to learn if I'm going wrong somewhere.

Now any federal system faces one issue. States have more responsibilities but their earnings are less. Which means the only way they can work is by depending on money transfers from the union.

Example: Nearly 60% of all govt spending happens through state budgets but they raise only ~36% of the revenues. This means they need revenues from the union.

What differentiates the Indian federal system is the deep inter-state differences in revenue raising capacity. Bihar's per-capita GSDP is 1/5th that of Haryana which has the highest per-capita GSDP. Such a large difference is unique to India.

Now low GSDP per capita means that state can't earn through their own taxes and fees. So, such a state depends even more on the union transfers even for doing its core functions.

An illustration for this point: state’s own taxes and fees make up ~75% of the total earnings of a state like Karnataka but that number is ~48% for MP. Remember, less GSDP per-capita means less taxes collected.

Now the central question is: why should MP receive ~52% of its revenues from the union while Karnataka is only receiving only ~25% of its total revenue?

To understand that, let’s see how union govt allocates money to states. Income taxes from individuals and companies are collected by the union directly. This is a big pool of money that needs to be redistributed across states.

It is done in two ways. One type is called a general purpose (GP) transfer. Think of it like cash given to the recipient. Which means the states can decide how to use this money, union govt has no control.

The second type is a specific purpose (SP) transfer. It is based on conditions - states should use an equivalent amount for health only or education only and so on. Think of it like a voucher that you can encash only on a particular item.

Now the purpose of both these transfers is quit different! GP are meant to *enable* states to provide comparable levels of public services at comparable tax rates by offsetting their revenue and cost disabilities.

OTOH, SP are meant to *ensure* at least a minimum standards of public services which are considered meritorious and have significant externalities across the country.

In general, it is good if amounts through GP >> amounts through SP. Because?
Because states will have more freedom to decide their priorities as GP amounts are unconditional. (Hope you’re awake!)

SP transfers should be restricted only to meritorious goods such as public health, education which have consequences beyond the states where problem exists. Ex: people will try to migrate to a state where these services are better.

Now let’s see what the history of GP and SP has been in India of late. GP is given by a constitutional body called Finance Commission (FC). 14th FC increased the total amount that states as a whole get compared to what the union keeps with itself! States were happy.

To decide which state should get more of the pie of GP, FC comes up with a formula. 14th FC’s formula for example, increased K’taka’s incoming GP by ~60%! MP also gained ~50%. May be because forest cover was one of the criteria used.

So far so good. But what about SP? SP is given mostly through Centrally Sponsored schemes (such as Swacch Bharat, MGNREGS etc). Currently there are 28 such major schemes. indiabudget.gov.in/ub2018-19/bag/…

Since SP’s purpose is to ensure that certain minimum standards for meritorious goods be met across the country, it obviously goes more to the poor and more populous states.

It is in every Indian's interest after all that there is no outbreak of an infectious disease in any part of the country for example whether it is in the north, south, east, or west.

So, what does this have to say of the north-south divide argument?

SP transfers will continue to go to the larger, poorer northern states such as UP and Bihar and its okay. The idea of punishing individuals elsewhere in the country just because these areas continue to languish goes diametrically against the Indian Republic’s spirit.

But yes, we should demand however is that SP funds be concentrated only on a few meritorious services and not on so many schemes. Instead, we need more GP for all states. More on this: thinkpragati.com/reforms/1046/t…

With 15th FC, there are concerns that union govt might want to reduce the GP pool that goes to all states and that is the right battle to fight. More on this: theprint.in/opinion/why-th…

Political formations from all states must emphasise that tax devolution is a constitutional entitlement of the states and not a knob at the mercy of the Union government. Any attempt to reduce the total tax devolution amount violates the federal spirit of the Constitution. /fin