The constitution (73rd and 74th) Amendment Acts, 1992 and Article 280 (3) (c) have altered the erstwhile fiscal devolution system and framework between the states and local governments. Under the new fiscal devolution system every state government is required to constitute, once in five years, a Finance Commission under articles 243 (I) and entrust it with the task of reviewing the financial position of local government and making recommendations as to the principles that should govern.
- The distribution between the state and the local governments of the net proceeds of the taxes, duties, tolls and fees leviable by the state.
- The determination of the taxes, duties, tolls and fees that may be assigned to or appropriated by the local government.
- The grant-in-aid to local government from the consolidate fund of the state.
A state legislature has a provide by law, for the composition of the SFC, the qualification which shall be requisite for appointment as members thereof, and the manners in which they shall be selected. The existing constitutional provisions also provide that the Commission shall determine their procedure and shall have such powers in the performance of their functions as the legislature of the state. The Governor shall cause every recommendation made by the commission with the explanatory memorandum as to the action taken to be laid before the legislature of the state. In regard to the maintenance of the accounts by the panchayats and their auditing, Article 243-J provides that “the legislature of a state may, be law, make provisions with respect to the maintenance of accounts by Panchyats and the auditing of such account.”
The 74th amendment of the constitution which is addressed to the municipal institutions had added one more mandatory provision. In the form of district planning committees to the domain of Pachayats. However, the crucial is a devolution of functional responsibilities, authority, power and financial resources on the panchayats which have been made discretionary for the state. Therefore, each state usually practice its own scheme of devolution, and in the process, the pattern and degree of devolution on panchayats significantly vary across the states, depending upon the functional canvas of the panchayats. Central Finance Commissions and State Finance Commission in context of local finance issues. Under Article, 280 of the Constitution, Central Finance Commission is constituted to make recommendations on sharing of union tax revenues, revenue deficit grant, grant-in-aid to local bodies, calamity relief and for up-gradation of standards of administration and special problems. Whereas the State Fiancé Commission is to mediate between the state and the local governments under Article 243 1 and 243 Y.
The expansion of the private sector and its opening to the global economy has resulted in significant changes in the dynamics of the Indian economy. Private investment rose from 6 percent of GDP in 1960 to 13 percent in 1990 and a recent peak of 25 percent in 2007, just before the global financial crisis. Commensurately, the development planning process in India has evolved, with indicative planning largely replacing the central planning model. Resources provided through the Five-Year Plans, Finance Commission dispositions and state level revenue collection processes have declined progressively as a share of the investible resources available to the Indian states. Nevertheless, public resources continue to play an important role in several states and, among them, Central Government resources play a dominant role in states such as Uttarakhand that have “Special Category” status.
The role of public finances in Uttarakhand is shaped by several considerations. Expansion of the state’s agricultural and industrial sectors faces geographical limitations which limit the tax base and the feasibility of raising user charges to augment its own revenues. At the same time, two facts dominate the need for high public expenditure—the state has sensitive international border areas up in the hills, and the very rationale for creating the state was earlier neglect and aspirations for better public services. Finally, there is tremendous pressure for the creation of employment within the state and, especially, in the Mid and High Hills, despite geographical constraints on large scale organized productive activities in these areas.
Fiscal balances improved substantially from 2003-04 to 2006-07, with the revenue deficit of 3.7 percent of GSDP turning into a revenue surplus of 2.9 percent, and the fiscal deficit dropping from 6.9 percent to 2.8 percent . However, subsequently, the revenue surplus was eroded, and 2009-10 ended with a revenue deficit of 2.5 percent. The fiscal deficit followed a similar pattern, with the temporary reduction in 2008-09 to 4.6 percent of GSDP, despite a significant worsening of the revenue account balance, achieved only through a substantial cutback in capital expenditure. It jumped to 8.6 percent of GSDP in 2009-10, which is a fairly high level by any standard, although not the highest during the decade. Similarly, the small primary surplus of 2006-07 turned into deficits immediately afterwards, and the level in 2009-10 (5.2 percent of GSDP) is only a little below the highest recorded deficit during the last decade. In general, therefore, the broad fiscal position seems to have deteriorated in Uttarakhand.
A decomposition of the broad trends shows that the marked deterioration of 2009-10 is distinct from the gradual erosion that was taking place in the 2006-09 period. The two years following the very encouraging fiscal outcomes of 2006-07 saw a small drop in revenue receipts combining with a small increase in expenditures to produce a gradual worsening of the broad fiscal balances. However, in the following year, 2009-10, there was a significant increase in revenues (from 21.5 percent of GSDP to 24.1 percent), mainly from own revenue sources.
At the same time, there was an even greater increase in expenditures (revenue and capital combined), from about 26 to 33 percent of GSDP. The jump in expenditures resulted from an expansion of salary and wage payments, which had dropped from 5.7 percent of GSDP in 2003-04 to 4.9 percent in 2006-07, but rose substantially in every year after that. They more than doubled to 11.5 percent by 2009- 10. Other components of revenue expenditure also increased, but by smaller margins. The substantial rise in pensions clearly reflected the impact of the pay revisions in the state following the Sixth Pay Commission awards for Central Government employees. Expenditures for the first three years after salary revision (starting 2008-09) include the effect of payment of salary arrears apart from the regular increase in salaries; a government decision was taken to spread the payment of arrears over a 3-year period to avoid a larger spike in expenditures. The fiscal imbalance is likely to have continued for 2010-11 as well, because the main reason—payment of salary arrears—remains. However, the official budget estimates for 2010-11 built in a smaller wage and pension bill compared to the revised estimates for 2009-10. The Government expected to manage a marginal revenue surplus and a fiscal deficit of only 3.4 percent of GSDP on the strength of an all-round expenditure compression and a substantial increase in tax devolution from the center. Expenditure compression is a necessary component of such an improvement. A closer look at the different components of the fiscal situation is needed to determine where the stress points lie and possible directions for maintaining fiscal sustainability.
Revenues
Own Tax Revenues
Own tax revenues of the state are collected primarily through the sales tax/VAT, state excise (mainly collections from liquor consumption), stamp duty and registration fees, and motor vehicle taxes. In addition, there are other minor taxes such as the land revenue and entertainment taxes and the electricity duty. The sales tax is both the largest and most buoyant revenue source among the four major taxes, and its share of own taxes is rising. The state excise tax has also been relatively buoyant since 2005-06. Motor vehicle taxes have been less buoyant, while stamp duties were quite buoyant until 2005-06, after which its buoyancy is negative.
Sales or Trade Tax/VAT
The prospects for the sales tax are unclear because of the uncertainties regarding the introduction of the Goods and Services Tax. The present system in the state is a mix of single point taxation of some commodities (‘non-VATable’) and a VAT-type multipoint tax with setoffs for other commodities. A national level discussions between the states and the Central Government have made some aspects clearer, but others are yet to be agreed. The issue of applicable rate(s) seems to have been settled, with three rates to be applied – 6 percent, 8 percent and 12 percent, excluding the special rates. This alone is likely to push the revenues up in Uttarakhand, provided the relevant price elasticities of demand for them are not too high. This is because commodities taxed at 4 percent will become taxable at 6 or 8 percent, while most of the commodities taxed at 12.5 percent at present will be taxable at 12 percent, with a few to be taxed at 8 percent. The ‘non-VATable’ group is likely to be taxed in the same manner as now, although whether liquor will continue to be taxed under GST or not is uncertain. The exemption list of the state is likely to remain largely the same. In principle, the addition of services to the tax base under GST should also add to the revenues, but collections are unlikely to be large as the services sector in Uttarakhand is small relative to many other states and just services classified as final goods would add to the tax base. On balance, it appears that the state will not lose, and in all probability it will gain revenue from the introduction of GST; the counterpoint is that the general price level in the state could see a rise, affecting households and businesses adversely. Further, good administration of the GST will be key, irrespective of the final organizational structure—adaptation of the existing sales tax machinery under the state’s supervision, or part of an autonomous revenue authority that pools together relevant central and state machineries.
State Excise Tax
The state excise revenue from alcoholic beverages is obtained from two main sources: country spirits, and beer and other “malt” and “foreign” liquor. A little less than a third of the total state excise collections are from country liquor, while a little more than 60 percent of the collections are from beer and other foreign liquor. Since all types of alcohol/spirits are under the control of the state excise department, taxes and various fees are also collected on industrial alcohol and on medicines and cosmetics containing alcohol. These and miscellaneous receipts account for the remainder, about 10 percent of the total collections. In most states of India, state excise collection from liquor has two elements—one representing the license fees collected from the vendors and the other a tax per unit of sale or excise duty proper. The relative contribution of these two elements varies from one state to another; in Uttarakhand, the duty element is larger.
The supply chain for liquor—production or import, export, wholesale and retail sale—is fully controlled, subject to licensing and payment of specified fees. In particular, licenses for retail sale outlets are usually limited by policy, and there is excess demand driven by assured and substantial profits with little risk. As such, the precise manner of allocating these licenses among prospective vendors—known as “settlement policy”—is often an important determinant of revenue collections from licenses. A revenue maximizing manner of settlement would be through auctioning the licenses, and this is used in some Indian states. But most states find it difficult to keep the auctions fair and prevent cartelization. Uttarakhand uses a lottery system, subject to conditions. Only vendors from within defined coverage areas are allowed to apply. Further, the license fees are based on a minimum guaranteed lifting (MGL) of excisable products specified for each vend, and a per unit fee applied to MGL; if the actual lifting is higher liftings attract higher pro-rated license fees. The excise policy judges demand by the number of applications for each vend, and hikes the unit vend fees according to demand according to a specified schedule in the excise tax policy. In principle, such a system has some elements of arbitrariness and discretion, while failing to garner as much revenue as would be available from a fair auction.
Although excise officials claim the rates are relatively high, in fact only the rates on country spirit are high than in surrounding states. Further, a look at the change in the specific duties on foreign liquor and beer indicate that the implicit ad valorem rates have been actually dropping over the years, considering the increase in prices of these products. This system automatically charges lower rates on liquor with lower alcohol content, which is an internationally accepted norm. However, the specific duties rob the tax of built-in elasticity (even buoyancy could be affected adversely, since discretionary changes in rates are not too frequent), and the single rate on all types of foreign liquor is not based on ability to pay. Under this system, very expensive wines, such as sparkling wine, would be charged a lower rate compared to much cheaper liquor like rum. Inclusion of an ad valorem element in the taxation of foreign liquor other than beer may be useful.
Non-military consumption of all types of liquor, foreign liquor and beer in particular, has been growing fast. While country liquor consumption in the state has gone up by about 50 percent between 2005-06 and 2009-10, beer consumption has increased by almost 250 percent (from 4,938 thousand bottles to 13,133 thousand), and foreign liquor consumption has increased from 12,252 thousand bottles to 19,993 thousand, i.e. by more than 50 percent. Thus, if an ad valorem element can be introduced on foreign liquor, the market is likely to be able to bear a little additional tax.
Stamp Duty and Registration Fees
This source of tax revenue consists of several elements such as judicial and non-judicial stamp duties and registration fees on various legal and financial instruments. But the overwhelming bulk of revenue is raised through the stamp duty on conveyances (i.e., temporary/revocable or permanent/irrevocable changes of right of use) of real estate. The rate of stamp duty on conveyances is legally defined as a progressive one based on slabs of the value of transaction, but the categories are such that most transactions are assessed at the highest slab, making the rate effectively proportional. This rate was 8 percent (plus 2 percent of additional stamp duty) from 2000-01 until 2007- 08. In 2008-09, the basic rate was reduced to 7 percent, and the additional stamp duty was reduced to one percent in 2009-10. In the current financial year, the basic rate has been brought down to 6 percent and the additional duty has been abolished. However, this is probably not the primary reason for the lack of buoyancy in stamp duty collections in the recent years. The growth in stamp duty was arrested in 2007-08, a year before the rate reduction program started. The stagnancy in collections had more to do with loss of tax base.
Motor Vehicle Taxation
Motor vehicle taxes consist of a basic rate specified for different types of motor vehicles and an additional tax on goods vehicles and stage carriages (passenger buses running on specified routes) registered in the State. For tax purposes, motor vehicles can be classified into three broad categories: (a) private vehicles including two-wheelers, private automobiles, and trailers attached to private automobiles, (b) commercial vehicles including 3-wheeler goods vehicles, other goods vehicles, tankers, multi-axle vehicles, 3-wheeler auto-rickshaws, and stage carriages of all sizes, and (c) contract carriages of all types.
A large part of the revenue under this head is raised from commercial vehicles. The relative tax rates on different types of vehicles are roughly aligned with expected road damage caused by different types of vehicles. The same type of consideration could justify differential rates for roads in the hills and plains. However, the taxation of goods vehicles and contract carriages could benefit from rationalization. The differential taxation of goods vehicles on the basis of use or route presupposes that each vehicle has a fixed area of operation or use. This is contrary to normal practice, except in the case of special purpose vehicles such as petrol/diesel tankers or refrigerated milk tankers. Efficient use of a vehicle fleet also requires the owner to allocate vehicles according to demand, and not fix uses or routes a priori. Moreover, such a system is costly to enforce.
For commercial passenger vehicles, the same type of consideration applies to contract carriages, although the rates (correctly) do not differentiate by type of route. However, in the case of stage carriages, the routes are indeed fixed and known, hence tax rate differentiation is practical. It would thus seem that rationalization would require the abolition of rate differentiation on the basis of route or use for goods vehicles. If the government decides to charge more for the use of hill roads, it may consider a transferable hill road permit system for goods vehicles. While this will not make enforcement any easier, it would at least allow transport operators to legally de-couple vehicles from routes.
Another area for possible rationalization is the light taxation of contract carriages relative to stage carriages. There is no clear reason for treating the same type of vehicle (buses) differently on the basis of how they are used. Further, stage carriages in any case pay more to the government through payments for route permits. Contract carriages can actually pay taxes slightly higher than stage carriages, and a transferable hill road permit could be introduced for them too, to align with the higher tax paid by stage carriages that ply hill routes.
Other State Taxes
Apart from the four major taxes, the own tax revenue of Uttarakhand also includes land revenue, the hotel receipts tax, entertainment tax and electricity duty. Of these, the first three land account for only small amounts (less than Rs. 10 crore). The collection of land revenues has dwindled for political reasons in most of the states in India. The hotel receipts tax and entertainment tax have small bases, for the former the result mainly of a policy decision (high level of tax base threshold) while the small base of the entertainment tax is outside the control of the state government. For its part, the Government has tried to widen the base as much as possible (from cinema theatres to cable TV, DTH TV services and even ropeways). The revenue from the electricity duty is more substantial, at around Rs. 70 crore in 2008-09. The receipts fluctuate somewhat, mainly because of irregular manner remittances to the government accounts by the collection agency (UPCL, a public sector entity owned by the state government). This tax is a unit rate on electricity consumption, and in that sense a simple addition to the price of electricity. Thus, the collection from this tax depends entirely on the use of power and success in collecting the dues against the electricity supplied.
Property Taxation
The property tax is the dominant own revenue source for urban local bodies (ULB) in the state. Improvements in property tax collection would benefit the ULB directly. However, it should also help the state government indirectly by reducing the need for the transfers on which the ULB are presently heavily dependent. Unfortunately, actual collections are below potential by substantial amounts, due to several shortcomings in the structure and administration of the tax. The system of taxation is based on an annual rental value method. In combination with the capital cost based estimation procedures and constrained by the operation of the Rent Control Act, the estimated property tax bases bear no resemblance to market rents.
Non-tax Revenues
The major sources of non-tax revenues in Uttarakhand are forestry, power and royalties from (minor) minerals.
Central Transfers
Uttarakhand depends heavily on Central transfers. Tax devolutions (the state’s share of central taxes) and grants together have ranged between 51 and 58 percent of the state’s revenue receipts. While devolutions have been above the state’s non-tax revenues, they have been below own-tax revenues. However, Central grants remain above all components of total revenue receipts. This is not unusual for Special Category states, which receive preferential treatment from both the Finance Commissions and the Planning Commission because of substantially higher per unit costs in the supply of public services.
A substantial part of the central transfers consist of those under centrally sponsored schemes (CSS). These are conditional transfers, and under-utilization implies missing out on available resources.