Special Category Status, Role of Finance

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Special Category Status to States

Various Chief Ministers across the nation have been demanding special status for their
respective states since last few years. This has led to fierce debates amongst the
proponents and critiques of the special category status.

The proponents argue that granting special status to these states will bring them at par
with those who have developed their industrial base by benefitting through the flawed
grant-to-states schemes by the Planning Commission of India over the years.

But not everybody is convinced as the critics argue that development does not come out
as a dole. In an era of open competition and liberalization granting special status to
States, which do not qualify as per the original criteria under political compulsions
would be detrimental to the interest of other deserving states.

The whole idea of a special category state was introduced in 1969 by the Fifth Finance
Commission, which as per the Gadgil formula gave special status to the states of
Nagaland, Assam and Jammu and Kashmir. Today eleven states in the country enjoy
this status including seven north-eastern states, Sikkim, Jammu Kashmir, Uttrakhand
and Himachal Pradesh.

As per the Gadgil formula “special status” is to be given to certain states because of
certain intrinsic factors which have contributed to their backwardness
historically. Some of these factors include:

1.
1. Hilly and difficult terrain;
2. Low population density or sizable share of tribal population;
3. Strategic location along borders with neighbouring countries;
4. Economic and infrastructural backwardness; and
5. Non-viable nature of state finances

Benefits of Special Category Status

The Planning Commission allocates funds to states through central assistance for state
plans. Central assistance can be broadly split into three components:

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 Normal Central Assistance (NCA),
Additional Central Assistance (ACA) and
Special Central Assistance (SCA)

NCA, the main assistance for state plans, is split to favour special category states: 11
states get 30% of the total assistance, while the other states share the remaining 70%.
The nature of the assistance also varies for special category states; NCA is split into 90%
grants and 10% loans for special category states, while the ratio between grants and
loans is 30:70 for other states.

For allocation among special category states, there are no explicit criteria for
distribution and funds are allocated on the basis of the state’s plan size and previous
plan expenditures. Allocation between non-special category states is determined by the
Gadgil Mukherjee formula, which gives weight to population (60%), per
capita income (25%), fiscal performance (7.5%) and special problems
(7.5%). However, as a proportion of total centre-state transfers NCA typically accounts
for a relatively small portion (around 5% of total transfers in 2011-12).

Special category states also receive specific assistance addressing features like hill areas,
tribal sub-plans and border areas. Beyond additional plan resources, special category
states can enjoy concessions in excise and customs duties, income tax rates and
corporate tax rates as determined by the government.

The Planning Commission also allocates funds for ACA (assistance for externally aided
projects and other specific project) and funds for Centrally Sponsored Schemes (CSS).
State-wise allocation of both ACA and CSS funds are prescribed by the centre.

Role of Finance Commission

Planning Commission allocations can be important for states, especially for the
functioning of certain schemes, but the most significant centre-state transfer is the
distribution of central tax revenues among states. The Finance Commission decides the
actual distribution and the current Finance Commission have set aside 32.5% of central
tax revenue for states.

In 2011-12, this amounted to Rs 2.5 lakh crore (57% of total transfers), making it the
largest transfer from the Centre to States. In addition, the Finance Commission
recommends the principles governing non-plan grants and loans to states. Examples of
grants would include funds for disaster relief, maintenance of roads and other state-
specific requests.

Among states, the distribution of tax revenue and grants is determined through a
formula accounting for population (25%), area (10%), fiscal capacity (47.5%) and fiscal
discipline (17.5%). Unlike the Planning Commission, the Finance Commission does not
distinguish between special and non-special category states in its allocation.

Other ways that can be explored without giving the Special Category Status
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Even though the Centre cannot grant special status to States based on political demands
it can infuse more funds to some non-special category states from its Backward Region
Grants Fund. The Centre can also ask the 14th Finance Commission to tweak the
formula for determining the transfer of central resources to states.

Centrally Sponsored Schemes (CSS)

In the areas requiring national effort, it is imperative for the Centre to make
interventions. The government of India tries to do this through various programmes
and policies including the CSS. Central Government has introduced several schemes in
areas that are a national priority like health, education, agriculture, skill development,
employment, urban development, rural infrastructure etc.

Several of these sectors fall in the sphere of activity of States. The share of all CSS as
percentage of GBS has increased continuously in the last three Plans. In the Eleventh
Plan it went up to 41.59% as against 38.64% in Tenth Plan and 31% in Ninth Plan States
have been raising concerns at various forums about lack of flexibility in CSS schemes
and adverse pressure created on the resources of states due to CSS etc., some of them
have been addressed below:

1. Inability to provide matching funds: To access the funds from center under
some CSS, there has to be a definite percentage contribution from the States. The
pattern of assistance to States varies. Generally it is Central Government’s
contribution of 90% for North-East States and 75%–100% in different schemes
for other States. The number of States, particularly the North-East States, Bihar
and Jharkhand have often represented that they have limitation of resources and
are not able to provide State’s share to enable them to access the required funds
under CSS.
2. Lack of flexibility: An important area impacting on efficient implementation of
CSS has been the need for flexibility in many of the schemes. India with its
different geographical regions, varied requirements of States, different levels of
infrastructure development, demographics and economic growth, requires
flexibility for States to plan their development.
3. It is necessary that CSS take into account the ongoing schemes in the States
so as to ensure convergence with the existing schemes. For example, if money is
provided under IAY for construction of houses and the State Government is also
putting its own resources, it may be possible to construct a house with a cement
roof, along with a toilet and rooms which have better interior. Another argument
to support this is that the cost of project is different in different areas and this
needs to be fully taken care of. For example, the cost of buildings in the North-
East and in the far- east corners of North-East has great variations.
4. Different accounting procedures: Accounting process is different in different
States for the same CSS scheme. It is, therefore, not possible to have an effective
Central monitoring and accounting system.

Way Ahead around CSS

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There is a need for reforms in designing of CSS, physical and financial norms, planning,
transfer of funds, monitoring and evaluation. There is also a need to meet the concerns
of the States on their inability to provide counter-part funds as the States are not able to
access these funds.

Distribution of CSS funds amongst different States should be based on transparent

notified guidelines. Such guidelines should be put on the website of the concerned
Ministries. There is also a need to cut down on the number of CSS. In the current
financial year, budgetary provision has been made for 137 CSS. The existing CSS/ACA
Schemes in the Twelfth Five-Year Plan have been restructured into 66 Schemes,
including Flagship Programmes.

Issues around GST

The GST or the Goods and Services Tax aims to create a common market throughout
India without any taxes on inter-state movement of goods. A Constitutional
Amendment Bill to facilitate the implementation of GST is currently pending in
Parliament. The Goods and Services Tax is being billed as a significant next step in
indirect tax reform since VAT was successfully introduced all over India. However, in
introducing GST, there are some objections from some State governments.

Objections by States on GST

1. The fiscal autonomy of States: The compensation mechanism for possible

revenue loss in future. If the same GST rate is applied to all States and the States
cannot impose any other taxes, some States may feel they would lose the power to
raise revenues, especially if they require the funds to come good on electoral
promises of distributing freebies.
2. Compensation Rates: The Centre is promising to compensate the States for any
revenue loss for the first three years after GST is introduced. But, a uniform rate
may not compensate the revenue loss for all the States because: some states are
more industrialized, some are more agricultural and some are resource-rich.

Therefore, some States feel they should have the power to impose supplementary taxes,
and at appropriate rates as necessary, even if a State-level GST is introduced. But, the
Centre is not in favor of allowing States this freedom as that would undermine the
objective of a single market with a uniform stable tax regime.

3. Disagreement over alcohol, spirits: States demand that alcoholic items should
be kept outside GST, whereas the Centre opines it should be under GST in order to
remove the cascading effect on GST paid on inputs such as raw material and packaging
material

Way Ahead for GST

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 1. Setting floor rates: In view of the apprehensions of the States, one option is to
set a floor rate instead of a single fixed rate for all the States. This is also necessary
to prevent unhealthy tax competition among States trying to attract investment,
with no real benefits to any State.

If at all a consensus emerges on a uniform rate, then possibly the States will want to
retain the power to impose additional duties and cesses, if needed, in the initial years
till revenues stabilize. This may be subject to approval from the GST Council or the
regulatory body that will have representatives from the Centre and the States.

1. Great Fiscal autonomy: Giving the States some degree of fiscal autonomy is
good also because it will force them to be fiscally responsible. Otherwise, some
States may blame the Centre for their lack of efforts to raise tax revenue by
arguing that their hands have been tied by the Centre as part of the GST deal and
hence it is the Centre’s responsibility to bail them out in case of any Budget
shortfall.

In making this transition, the paramount objective should be to ensure that the basic
federal structure in terms of the relative revenue and fiscal autonomies of the Central
and State governments are not disturbed.

Federalism and Foreign Policy

Even though foreign policy is the prerogative of the Central government and the
Constitution does not allow the states to take initiatives in these matters, the West
Bengal Government challenged the Central Foreign policy on sharing the waters of river
Teesta by stalling the bilateral treaty with Bangladesh.

Some of the states have been arguing in favour of a role for the states in the foreign
policy of the country, particularly, states with an international border are vocal on
issues, which directly or indirectly impact them. Similarly, when the issue of border
trade with China came up for discussion, Sikkim’s views were sought. Tamil Nadu has
demanded the intervention on the issue of Tamil killings in Sri Lanka every now and
then.

The north-eastern States of the country have borders with various countries like
Myanmar, Bangladesh, China, Bhutan and Nepal and their proximity of countries east
of India demands that their economies should benefit more from the Look East Policy.
North Eastern State leaders have been asserting that their views should be sought while
conducting negotiations with neighbouring countries on economic and political issues.

There is a case for institutionalizing the process of consultation and involvement of

States, which are affected by a particular foreign or security policy measure. Barring
Haryana, Madhya Pradesh, Jharkhand, and Chhattisgarh, all Indian States share
borders with other countries, or with the international waters of the sea. In that sense,
they have interests or issues that may intersect with the foreign and security policies of
the country.
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Among the various governmental systems, the U.S. is one in which the interests of its
federal constituents are taken into account in the formulation and exercise of foreign
and security policies. This was part of the large and small States compromise that
resulted in its constitution.

This enables its Upper Chamber, the Senate, to be the lead house on foreign policy
issues — ratifying international agreements, approving appointments of envoys and so
on. The Senate, as is well known, has a membership which is not based on population —
each State, large and small, populous or otherwise, has the same number of Senators.

It would be difficult to graft something like the U.S. system on to the Indian system. Yet,
clearly, the time has come when Mizoram and Nagaland also have a say in India’s
Myanmar policy, instead of merely having to bear its consequences.

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