Thread by @shrikanth_krish

Public Finance is something I am mostly ignorant about

Tried to get some sense by reading up a bit on the 14th Finance Commission

Among other things the Finance Commission determines the allocation of Central Taxes across states

The Criteria baffle me
(source : wiki)

There are so many things wrong about this kind of allocation -

In an ideal world the Central govt should not redistribute Central taxes to states. But spend it using its own discretion

With the states spending its own taxes and not relying on the Central govt

But if at all you have to allocate, this seems such a terrible way to do it

Its so very arbitrary and quirky. So hard to rationalize

The allocation is not based on the Center's assessment on the current state of public goods and which state is most lacking in public goods

Instead it is based on arbitrary factors like population, area, forest cover, and income

It punishes richer states, as the "income distance" component measures the PCI difference of each state relative to richest state

So the poorer you are, the more money you get

Which may be OK. I am sort of OK with that.

But why assume that poorer states have much greater need for public goods?

It may hardly be a perfect correlation

Many poor states may have very good public infrastructure - better than some of the richer states

Another quirk - Between two states with similar populations, but one with a bigger area, it punishes the more densely populated state

Does that make any sense?

So here's how the allocation looks today -

Tamil Nadu gets less money than Karnataka though the two states have similar incomes, and TN has a higher population

Presumably because of Karnataka's greater area?

This is ridiculous

Bihar's share is only a notch higher than Madhya Pradesh - 9.7% vs 7.5%

This is despite Bihar being way poorer than MP, and much bigger than MP in terms of population

Largely because of MP's greater area and forest cover?

This makes no sense to be whatsoever

Another oddity

Haryana and Uttarakhand have almost the same share (1.08% and 1.05%)

Though Haryana has 25MM people and Uttarakhand less than half that number (10MM)

None of these criteria bake in how badly the people of that state need public goods

Nor is it based on the state government's delivery mechanisms or fiscal discipline

There are no incentives built in to these criteria for states to work harder for money

The message being sent out is - Stay poor, stay rural. Have more forests. We will give you more money.

How is this a good model for competitive federalism?
Where is the incentive for states to compete?

If it's indeed such a hard problem, keep it simple. Just allocate money based on population. May sound terribly simplistic, which it is.

But even that is in my view better than the mess we see here.