Is it right for a rich state like Kerala to lament about falling central transfers?

Kerala’s development narrative or more commonly called the ‘Kerala Model’, caught international attention, as the State achieved high human development indices, even as it had comparatively low levels of per capita income.

Renowned economists Amartya Sen and Jean Dreaze wrote comparing the development narratives of Sri Lanka, China and Kerala. The former two were sovereign states with wide taxing powers and the latter was a State in a national polity with limited taxing powers. Later. Sri Lanka became known for its crisis and not an achievement in human development indicators.

There are some doomsday predictors who compare Sri Lanka and Kerala, but they cannot be taken at face value, again for the reason that a sub-national economy and a nation can not be compared.

Throughout the long decades, till 1989, Kerala’s economic growth was in what was called by researchers (late K K Subhramanian and Shyam Prasad of Centre for Development Studies) as a stagnation phase.

Kerala’s economic growth picked up and with declining population growth, the State’s relative position in per capita incomes significantly improved. As per the report of the Fifteenth Finance Commission (15th FC), Kerala ranks fourth among Indian States in per capita income. In overall human development indicators, the State ranks first, as per the report of the NITI Aayog.

Kerala's growth paradox
Experts advanced the hypothesis that Kerala is in a virtuous cycle of growth with a high level of human development indicators and rising per capita incomes. In a study, this writer expressed doubts about the robustness of virtuosity (Mohan and Shyjan Centre for Development Studies, Working Paper Number 375).

Today, we are a very high per capita income State. Has the boon turned into a bane?

The expanding pie of the Gross State Domestic Product (GSDP) and declining population growth have made us a rich State.

The most direct consequence is the declining inter-se share in the divisible pool of taxes collected by the Union and distributed to the States based on the recommendation of the Finance Commissions.

Income Distance, in other words, the gap in per capita income of the Xth State from that of the highest per capita income State (or sometimes the average of the three highest per capita incomes). The larger this gap, the devolution share of the Xth State will be higher.

The weightage of the Income Distance criterion in the tax-sharing formula recommended by the Finance Commission is quite high. It was 62.5 per cent in the recommendation of the 11th FC (2000-2005) and 45 per cent in the recommendation of the 15th FC (2019-20 to 2025-26).

In the interregnum, Kerala’s per capita income has been consistently rising and Income Distance has come down.

Population, which is the criterion having the next highest weightage, around 25 per cent is now based on the 2011 Census and not the 1971 Census.

These two have resulted in Kerala’s inter-se share in Union taxes distributed on the basis of Finance Commission recommendations coming down from 3.05 per cent in 2000-2005 to 1.92 per cent in 2019-20 to 2025-26.

Is Kerala's anti-Centre stand justified?
The State is complaining about this declining tax share. What is to be noted here is the basic purpose behind Finance Commission transfers.

One is to address Vertical Fiscal Imbalances. This arises from higher revenue-raising powers of the Centre and larger expenditure obligations of the States, especially in social sectors like health and education.

Next, is to address Horizontal Fiscal Imbalances, that is between States with lower per capita income and one’s with relatively higher per capita income. The second criterion is not favourable to a high per capita income State like Kerala.

In a polity where Horizontal Fiscal Imbalances need addressing, lest there should be adverse political consequences, Kerala’s complaint about declining inter-se tax share is not likely to find a favourable response from the Finance Commission or Union Government.

In a federation, a rich State cannot get an increasing share of inter-se tax distribution. If criteria are devised in a way that richer State gets a rising share, poorer States will have to get a lower share. This will not help amelioration of Horizontal Fiscal Imbalances. In Germany, richer Landers transfer to poorer ones.

State might
But, the pressure put by the southern states, led to Fifteenth Finance Commission, introducing a criterion of Demographic Achievement, based on lower fertility rates, scaled by the 1971 population. Had this not been there, Kerala would have got a still lower inter-se tax share.

We need to see that during 2019-20 to 2023-24, we got more than Rs 50,000 crore as grants under Article 275 of the Constitution (commonly called Revenue Deficit grants). This is now tapering off and will come to nil during 2024-25 and 2025-26.

The grants under Article 275 were to be reviewed as per the Terms of Reference of the Fifteenth Finance Commission, but the resistance put up by States including Kerala was a factor in preventing it.

Solving the Kerala riddle
It is well recognised that the unprecedented adverse impact of Covid-19, upset the fiscal consolidation path of countries and sub-national entities across countries. Kerala also was affected. As we see from the glide path of the State Budget, 2023, the fiscal consolidation path is clear.

The question to be addressed here is how we face the fiscal paradox. Kerala is a rich State with poor public finance, characterised by chronic revenue deficits. The central tax share is not going to increase if our per capita income keeps rising.

What is the option? Mobilise more resources, tax and non-tax. We have upgraded government schools and hospitals. Statistics also reveal that more people are utilising these public sector services.

There is nothing wrong in levying reasonable user charges on the well-to-do who avail of social services in the public sector. If quality can be assured, they will be willing to pay. Compare the fees charged by the private sector and levy at least half of them. Use the amount to cross-subsidise the poorer sections. This has to be seriously considered.

Fuel shock for social security
Kerala is an ageing society. We are on the other end of the demographic curve in contrast to other parts of the country. Social security for the aged is an issue. To finance the same, the State has imposed new cesses. Criticism is raging about their inflationary impact.

As regards petroleum products' price hikes, it can have an impact on government finances both ways. Government is also a consumer of fuel. The costs can go up. The operating cost of public sector transport entities can also rise.

Government should focus on scientific assessment of land tax, property tax and user charges. There is no need for low rates across the board and universal subsidies.

Class conflicts
Kerala society has numerous class fractions or interest groups. The nomenclature can vary according to one’s ideological beliefs. Government employees, traders, and youth including rank holders of Public Service Commission (PSC)examinations are a few.

Their interests come into conflict, whenever a fiscal consolidation measure is suggested.

The retirement age hike to 57-60 will be supported by the Government employees, but will stridently be opposed by the Youth, especially the PSC rank holders. Traditional measures of tax enforcement may be favoured by officials but will be resisted by the traders.

Reforms in higher education including autonomous Centres of Excellence with private participation will have opponents. There is a need for introspection into syllabus restructuring, academic administration, attaining a spirit of excellence etc. and this has to be done without strings of partisan thinking.

We have around 116 public enterprises, and it is reported that many have turned around. But we need to look quite seriously at making them run without State help, as State finances are stretched to limits. There has to be a plan for a sustained better return on the capital invested.

Anything which is music to one group’s interest is abhorrent to the other. Every measure of expenditure rationalisation will meet with resistance from one group or the other.

It is common knowledge that the actual value transacted in the purchase and sale of land is a multiple of what is recorded for stamp duty purposes. Still, when fair value is raised, why a section is crying foul?

Environmental enthusiasts and those with a Promethean development spirit are also in conflict. Can one side be taken and the other ignored? There are evident warning signals. Can we turn Nelson’s eye to that? This is a difficult balancing act, but we do need a development narrative, which cannot endanger our immediate future.

Are we progressive enough?
Though, we focus on a single paradox here, let us also be attentive to the fact that obscurantist practices which are alien to any modern society are in vogue, though the incidents are stray. But not even a single one should take place.

Freedom and democracy have to percolate more deeply as values in our society. Though there are functioning Local Governments, we need to ensure a sense of participation in every citizen, not as a member of any organised group, but one who can speak her/ his mind freely.

In the post-liberalisation era, after the 1990s, the general perception of government has undergone a change. The feeling of ‘less the better’ has gained currency.

Problem with government bashing
But in times of crisis, including ones like the Covid-19 pandemic, the case for state intervention was indisputable. The consequence of the general anti-state expansion feeling is that much of the spending by the state is viewed as profligacy.

The security of leaders, purchase of vehicles for ministers etc. are reasoned out as the cause of fiscal stress. If you peruse the Budget documents, it can be seen that these account for only 0.009 per cent of the total revenue expenditure estimated in the budget. The demonstration effect can be there, but the decibel of propaganda is much more than what is warranted.

In a democracy, if there are other reasons, one is welcome to criticise any spending, irrespective of the amounts involved.

What is sustaining the Kerala paradox?
In Kerala society, conflict of interests between groups is strengthening the recent fiscal paradox of a rich State and poor public finances. It is viewed that, when there is no single powerful class that can dominate and there are many class fractions or interest groups, State can attain relative autonomy (as Poulantzas stated).

In certain such contexts, the state can be termed Bonapartist (after Karl Marx wrote about the French political situation, in which he talked about class fractions in ‘Eighteenth Brumaire of Louis Bonaparte’, 1852).

Kerala is a State in the Indian Union. If one talks about whether it s Bonapartist or not, it can be strongly criticised by political scientists, especially traditional Marxists, who will argue that sub-national entities cannot be discussed separately from the national or international context.

Be that as it may, the State of Kerala and its leadership for the last seven decades, have been increasingly playing the role of conflict resolution and management, mostly by postponing the difficult but inevitable to a future date. That date is drawing nearer, as can be seen from the fiscal limits in which we are operating.

The latest paradox of the richness of people and poverty of public finance needs a resolution. This is easier said than done in a sharply polarised polity, balancing on the relative power of fragile combinations of social coalitions.

Can there be a consensus to resolve this paradox? Or do we need harsher remedies? Only time will tell. But one thing is clear, conflicts of interest cannot be managed with placebos for long.
(The writer is former Income Tax commissioner)