2B Flashcards
What his Fiscal Federalism and what is the role of Finance commission?
Fiscal Federalism refers to the division of responsibilities of i) taxation and ii) expenditure between the different levels of the government. While the 7th schedule assigns many responsibilities to the States but their taxation power is relatively lower than Union’s. So, Finance Commission plays a key role in transferring union’s revenue resources to the state.
Composition of Finance commission? eligibility for reappointment
- Article 280: President of India forms a Finance Commission (a quasi-judicial body) every 5th Year or earlier, with 1 chairman and 4 members.
- Eligible for re-appointment.
- Recommendations are not binding on the government but usually not rejected.
15th FC Terms of Reference (TOR) ?
President of India has ordered them to study and recommend following:
- Union Taxes’ vertical devolution to the states, and its horizontal distribution among the states. (except cess, surcharge and IGST).
- Union’s grant-in-aids to the states.
- How to augment State Govts’ Consolidated funds to help their PRI/ULBs
- Any other matters referred by the President of India such as:
✓ Use Census-2011 for your calculation.
✓ Keep in mind Union’s responsibilities for New India 2022 vision.
✓ Recommend measures for Fiscal Discipline/ Consolidation for the Union and State governments.
✓ Should union continue to provide revenue deficit grants to States?
✓ How to finance the disaster management initiatives?
✓ Performance based incentives to the state governments?
✓ (2019-Jul) suggest ways for allocation of non-lapsable funds for defence and internal security.
✓ (2019-Oct) Award for the UT of J&K. (This terms of reference required under JAMMU AND KASHMIR REORGANISATION ACT, 2019.
15th FC TOR: Apprehension of the states?
States Fear#1: Vision for New India 2022
States fear#2: Performance based incentives
States fear#3: Census-2011
States fear#4: Debt and Grants
FC: Vertical devolution from union to States?
Finance Commission recommends the vertical devolution from the ‘divisible pool’ of union taxes. (Here IGST, Cess, Surcharge not counted.)
12 FC -2005-2010 - C.Rangarajan - 30.5%
13th FC 2010-2015 - Vijay Kelkar - 32%
14th FC 2015-2020 - YV Reddy - 42%
15th FC - 2020-2021 - NK Singh - 41%
*15th FC’s justification: Compared to 14th FC, 1% extra Union should keep for UTs of J&K & Ladakh’s security & other needs.
How is horizontal tax devolution done among states according to 14th FC?
Finance Commission also gives formula for How to distribute states’ shares horizontally with individual States. 14th FC (YV Reddy)’s formula was…
Population: as per Census 1971 - 17%
Demographic Change as per Census 2011 (To consider the migration angle.) - 10%
Income-Distance: Based on per capita income of a state (GSDP ÷ its population). Accordingly, poorer states get more weight - 50%
Area: more area more weight - 15%
Forest-Cover: more forest cover more weight because of Opportunity cost (State can’t allow industries there, else it could have obtained some taxes) - 8%
Based on above formula, Highest to Lowest: Uttar Pradesh > Bihar > MP > WB > MH > Raj> ….. > Mizoram > Goa > Sikkim.
How is horizontal tax devolution done among states according to 15th FC?
- Income Distance - 45%
- Area - 15%
- Population (as per Census-2011) - 15%
- Demographic Performance: States that have ⬇ Total Fertility Rate (TFR), will get ⬆₹₹. - 12.5%
- Forest and Ecology - 10%
- Tax Effort: States who’ve improved their per capita tax collection in the last 3 years = get more ₹₹ - 2.5%
Finance Commissions & the fate of UTs of J&K & Ladakh?
Until 10th Finance Commission, the FC would also prescribe the revenue sharing formula between the Union Government and Union Territories.
➢ But this practice stopped since 11th finance commission i.e. Finance ministry itself
decides how much revenue will be shared with Union Territories based on its own
discretion
➢ Finance Commission no longer prescribed formula in this regard. But,
➢ 31st October 2019: The state of Jammu Kashmir was officially split into the union territories of Jammu Kashmir and union territory of Ladakh.
➢ Jammu and Kashmir Reorganization Act, 2019 mandates that:
o Whatever amount the former state of J&K was supposed to receive between 31/10/2019 to 31/3/2020 (as per 14th FC formula) …It will be distributed between these two new union territories on the basis of population ratio and other parameters.
o President of India shall require 15th FC to make award for UT of J&K.
o However, looking the 15th FC report, no separate share is given in vertical / horizontal tax devolutions. Simply 1% extra kept with Union to look after J&K & Ladakh, compared to 14th FC.
Grants suggested by 15th FC (in ⬇decreasing order, 2020-21)
1) Local Bodies Grants (90k cr)
2) Post-Devolution Revenue Deficit Grants (74kcr)
3) Disaster Management Grants (41kcr)
4) Sector Specific Grants: Nutrition (~7700cr)
5) Special Grants: (~6700kcr)
6) Performance-based incentives
States eligible for Post devolution Revenue Deficit Grants
Only 14 states eligible: Assam, Himachal Pradesh, Manipur, Meghalaya, Mizoram, Nagaland, Sikkim, Tripura, Uttarakhand, Andhra,Kerala, Punjab, Tamil Nadu, West Bengal.
Disaster Management Act, 2005 is under which ministry?
Disaster Management Act, 2005 → Ministry of Home Affairs looks after the subject.
Sectors under Sector Specific Grants in FC?
Seven sectors: health, pre primary education, judiciary, rural connectivity, railways, statistics, housing.
At present, 15th FC only recommended health → Nutrition grant- which ministry oversees this?
Ministry of Women and Child Development (MoWCD) will oversee its utilization.
States eligible for Special grants?
Only 3 states eligible: Karnataka, Telangana and Mizoram.
Some other recommendations by 15th FC to Govt
Some States have requested special category status But it’s not part of our mandate/Terms of Reference. So we’ve nothing to say on this matter.
Reform the direct taxation system → increase tax collection.
Reform GST’s operational challenges, slabs and rates.
Review the outcomes of all Government schemes. Merge/ abolish non-essential schemes → reduce Expenditure.
We need a law on “Public Financial Management System” it’ll prescribe the budgeting, accounting, internal control and audit standards to be followed at all levels of government.
Govt should follow FRBM Act with full sincerity in letter and spirit.
Tax devolution and grants for states under AB?
Corona = Union’s tax income decreased but still under Atma-Nirbhar → Union has given assurance to release Tax Devolution and grants to the states as per the figures announced in the Budget and Finance Commission report.
FC, PC, NIITI Aayog - constitutional/statutory or executive bodies? chairman?
FC- Constitutional body Art 280
PC and NITI - Created by executive resolution, so neither constitutional non statutory. Both headed by Prime Minister as the chairman.
FC, PC, NIITI Aayog - Year formed and action plan?
FC - 1951: 1st FC setup under KC Neogy
PC - - 1951: PC set up and over the years designed 12 Five Year plans (12th FYP: 2012-2017)
- 2014: Dissolved by 16th LokSabha
NITI - - 2015: Formed.
- Three Year Action Agenda (2017-20).
- Seven Year Strategy Document.
- Fifteen Year Vision Document (2017-32).
Brief functions of FC
- Taxes’ Vertical Devolution and horizontal distribution among states.
- any other matters referred by the President in TOR
- Each Finance Commission arrived at its own methodology. E.g. 14th FC: 42% vertical, and 5 factor formula for horizontal distribution.
Brief functions of PC
- How much money should union give to each state for implementation of Union’s centrally sponsored schemes (CSS)?
- How much money should union government give to the five year plans of the state governments?
- To answer these Qs, PC would use Gadgil Mukherjee formula (designed in 8TH FYP)- based on population, per capita income, special problems etc. of a state.
Brief functions of NITI Aayog
It is not in its scope of work to decide how much money should be given to each state. That component is decided by the Finance Ministry.
- NITI’s primary objective is to serve as the think tank of the Government of India,
- Helps in policy design.
- Helps in monitoring schemes’ through its dashboard e.g. ‘School Education Quality Index’, ‘SDG India Index’, ‘Digital Transformation Index’
(Pre19-SetA) Q69. In India, which of the following review(s) the independent regulators in sectors like telecommunications, insurance, electricity etc. ?
- Ad Hoc Committees set up by the Parliament.
- Parliamentary Department Related Standing Committees
- FinanceCommission
- Financial Sector Legislative Reforms Commission
- NITI Aayog
Answer Codes: (a) 1 and 2 (b) 1 , 3 and 4 (c) 3, 4 and 5 (d) 2 and 5
A
What are special category states and its benefits?
- 1952: The National Development Council (NDC) was set up, consisting of PM, CMs and other representatives to approve the five year plans prepared by the Planning Commission. But became obsolete with establishment of NITI Aayog.
- 1969: 5th Finance Commission recommended giving extra funds and tax-relief to certain disadvantaged states. Over the years, NDC added more states into the Special Category List based on
✓ (i) hilly and difficult terrain
✓ (ii) low population density and / or sizeable share of tribal population
✓ (iii) strategic location along borders with neighbouring countries
✓ (iv) economic/infrastructural backwardness
✓ (v) non-viable nature of state finances. - Examples: 8 North Eastern states and 3 Himalayan States (JK, Uttarakhand, HP). Post- 370 removal, J&K is no longer in this list.
- Benefits of Sp.Cat. States?
✓ Industrialists will be given benefits in Union-taxes for setting up factories in these states.
✓ In Centrally Sponsored Schemes (CSS) Union will bear
higher burden (90:10).
✓ FC & PC would assign more weightage in their formulas to give’em more funds.
- 14th FC: Previous Finance Commissions would assign extra weightage & funds to Sp.Cat states, but 14th FC stopped this practice.
- But, whenever elections are near, W.Bengal, Bihar and Andhra CMs would demand Sp.Cat. status & blame Union for ‘injustice’.
- 15th FC: Some States have requested special category status. But it’s not part of their mandate/Terms of Reference.
- So, at present, Sp.Cat states don’t get additional revenue/grants in FC’s formula. Although, Union upon its own discretion continues to give them certain benefits in CSS.
Criticism by ES for Special Category states
Economic survey 2016-17: Noted that Sp.Cat states have received lot of funds & grant from previous FCs and PCs, and yet they have not made any tangible progress in improving public administration or removing poverty (=” Aid Curse”).
Similar problem with the States having abundant mineral resources (“Resource Curse”).
- Economic Survey 2017-18: Noted that compared to Brazil, Germany and other countries with federal polity, India’s State Governments and Local Bodies are collecting less amount of tax for two reasons :
- 1) Constitution has not given them sufficient taxation powers.
- 2) Even where constitution gave them powers like collection of Agricultural Income Tax, Land Revenue, Property Tax: The States/Local Bodies are shy of collecting taxes due to electoral politics.
- Result? Poor quality of Public Schools, Public Transport, Police, Drinking Water and Sanitation.
Cost sharing for Sp.Cat States and Hill Union Territory Status for J&K?
While Finance commissions no longer give extra weightage to ‘Sp.Category States’ in horizontal tax distribution formula, but Union provides them additional funding for their welfare schemes from Union’s own pocket.
“Special Category States”
- North-Eastern States, and TWO Himalayan Hilly States: Himachal Pradesh and Uttarakhand# - Depending on the scheme, union may contribute 80-90% of the scheme cost, rest will be borne by the State.
- Other States: who are not in above category (UP, Bihar, etc.) and Union territory (UT) with legislature: Delhi, Puducherry, Jammu & Kashmir - Union may bear lower burden than Sp. Category states e.g. 50:50, 60:40 etc.
UT without legislature: Ladakh, Andaman Nicobar etc. - 100% funded by Union
#Before removal of Article 370, the State of J&K was previously in Special category. But as a UT with legislature, J&K will get lower assistance from Union in the welfare schemes. So, 2019-Aug: Central Government considering creating a new category ‘Hilly Union Territory' so J&K may continue to received 90:10 funding.
What is tax planning or tax mitigation?
When person invests money in LIC/PPF/Pension funds etc.in such manner that he can claim various deductions legally available in the Income Tax Act. It’s neither illegal nor unethical.
What is black money?
It is an income or transaction that is taxable yet NOT reported to the tax authorities/concealed from the tax authority.
What is Parallel Economy?
The economy that runs on black money.
What is Tax Evasion?
When person hides income or transaction from tax authorities, and thereby evades paying taxes. It’s illegal.
What is Tax Avoidance?
When person discloses his income and transactions to tax authorities but uses legal loopholes to avoid paying taxes.
E.g. Bollywood stars who register digital media companies in Tax Havens. It may not be illegal in every case, but still unethical.
What is a Tax Haven?
Is a country that demands little taxes from foreigners and offers legal loopholes for Tax Avoidance & opportunities for Tax Evasion. E.g. Liechtenstein, Mauritius, Marshall Islands, Cayman Islands, Panama, Nauru, Vanuatu etc. These countries are geographically small, & without viable economy. So they offer such mechanism to attract foreign investors and foreign tourists.
What is Money laundering?
- When drug trafficking, ransom, corruption and other criminal activity generates substantial profits, the criminal tries to spend / invest / hide the money without attracting attention.
- Money laundering is the process of disguising the
source of money, as if it came from a legitimate activity, & then channelize it into banks, share market and other financial intermediaries.
What is Hawala?
- Hawala is an illegal money transfer / remittance system. Money is paid to an agent who instructs an associate in the relevant country or area to pay the final recipient.
- Although used by Indian workers in middle east because lower commission than post-office/bank transfers, + better network in remote areas.
What are Shell firms, Post-box/ Letter-box companies?
They do not have any active business operations. Created with sole objective of money laundering/tax evasion/avoidance E.g.
Mishail Packers and Printers Pvt Ltd. allegedly setup by Misa Bharti Yadav to launder ₹1.2 crores (as per Enforcement Directorate).
What are Panama Papers (2016) Paradise Papers (2017) Mauritius papers (2018)?
- International Consortium of Investigative Journalists is a USA based nonprofit organization.
- They released these incriminating documents from certain law firms in tax havens & showed how notable people across the world engaged in tax avoidance/ evasion. Amitabh Bachchan & Aishwarya Rai also named in some them.
What is Tax Terrorism?
- Happens when tax authorities put undue pressure on an honest taxpayer to pay more taxes.
- 2012: Vodafone won a case against income tax department in the supreme court related to Capital Gains Tax on purchase of Hutch mobile company.
- Afterwards, UPA government amended the Income Tax Act with retrospective effect and issued fresh notices against Vodafone. This is called Tax Terrorism.
What is TDS/TCS?
Tax Deduction at Source (TDS)
Tax Collection at Source (TCS)
These are the mechanism to discourage tax evasion.
What is aPAN Card?
10 letters alphanumeric numbered assigned to all taxpayers in India by Income Tax Dept.
What are the notable organisations which fight against black money?
Enforcement Directorate (ED) Directorate of Revenue Intelligence Financial Intelligence unit (FIU-2004) Financial Action Task Force (FATF-1989) OECD (1961)
