Tuesday, December 4, 2007

The Finance Commission (FC) & the Sixth Pay Commission

Comparing the Finance Commission (FC) with the Pay Commission is a bit like comparing an accountant with a movie star. They’re just not in the same league. The Pay Commission hands out goodies by the bagful to a large and vocal section of the population. The Finance Commission, in contrast, does the more prosaic job of, among other things, picking up the pieces after the Pay Commission has done the damage!

Even so, when the appointment of the Thirteenth Finance Commission evokes so little interest, even among financial dailies, it can mean only two things. One, the mandate of the Commission, to determine the sharing of tax revenues between the Centre and the states and between states, is seen as a largely settled issue, now that we’ve had twelve FCs and the broad contours of the sharing process have been laid down.

Two, buoyant tax revenues, both at the Centre and the states have taken the edge off what has traditionally been a highly contentious issue. Add to this the preoccupation with other issues such as the possible fallout of the subprime crisis on capital flows, Nandigram, the nuclear deal and so on and it is no wonder esoteric fiscal issues involving ‘vertical’ equity (between Centre and states) and ‘horizontal equity’(between states) have been relegated to the backburner.

There is, of course, a third, admittedly facile, explanation. This is the Thirteenth Finance Commission and in one of those uncanny quirks of fate, was also notified on 13 November 2007; hence the silence! On a more serious vein, the Thirteenth Finance Commission has some notable firsts to its credit.

It is the first time in history that the chairman and all members, with the exception of B K Chaturvedi, a retired bureaucrat, are economists (though whether that is a plus is debatable). It is also the first time that we have a woman member, Indira Rajaraman, Professor Emeritus at the capital’s National Institute of Public Finance and Policy.

But if the Commission is not to go down as just another ‘formula tweaker’ it will have to do more. It will have to deliver on its ambitious terms of reference (TOR). Its task has been made more difficult by two developments that will inexorably shape the fisc during the five years commencing 2010 — one, the Sixth Pay Commission recommendations and two, the Goods and Services Tax (GST), slated to come into effect from April 2010.

The first, the Pay Commission report, is a ‘known unknown’, in the sense that though there is no doubt it will hit Centre and state finances hard, the precise impact is a little harder to work out. This is because its recommendations usually have a ripple effect and the full impact will be known only after a while. The second, GST, however, is an ‘unknown unknown’. It is far from clear if the country will be ready to implement GST from April 2010 (remember, it was almost two decades before VAT became a reality).

The impact of GST on central and state revenues is also unclear. Yes, we know now that GST will have a dual structure (where tax is levied by the Centre and the states) but the actual rates are yet to be decided; consensus is unlikely to be easy but the final model will need states’ approval.