Finance Commission Needs Greater Transparency in Tax Devolution

Fiscal Opacity in India’s Federal System

India’s federal structure is under increasing strain, particularly regarding tax devolution between the Centre and states. The Finance Commission plays a pivotal role in determining tax transfers, yet its workings remain largely opaque. One of the key concerns is the lack of transparency in how devolution formulae are designed and modified over time.

The absence of publicly available data on these decisions has raised concerns among economists and policymakers. Despite Finance Commission recommendations being binding and accepted without amendment, the reasoning behind major changes remains unclear.

Fiscal Transparency: A Critical Gap

The International Monetary Fund (IMF) defines fiscal transparency as the clarity, reliability, and accessibility of government fiscal information. However, in India:

• Finance Commission data is not systematically preserved or made public.
• Criteria for tax-sharing formula changes lack sufficient explanation.
• Even the cost of running a Finance Commission remains undisclosed.

Professor Arvind Panagariya, Chairman of the 16th Finance Commission, recently acknowledged this issue, stating that Finance Commission data needs to be centralized in a public portal for better access.

The Need for a Public Data Portal

Several past experts have emphasized the importance of fiscal transparency:

• Professor Indira Rajaraman criticized the Finance Commission’s lack of justification for altering tax-sharing formulae.
• Professor M. Govinda Rao highlighted the need for more transparent discussions on equity vs. efficiency in fiscal transfers.
• The 14th Finance Commission stressed that transparency requires comprehensive yet concise documentation that is understandable to the public.

With the 16th Finance Commission currently deciding tax devolution, the demand for a public finance data portal is more pressing than ever. This portal could provide:

• A repository of past Finance Commission reports and justifications for tax transfers.
• Comparative data on state finances, ensuring greater accountability.
• Public access to key fiscal parameters, such as GSDP data, which influences the “income distance” factor in tax distribution (currently weighted at 45% in the devolution formula).

Impact of Uneven Fiscal Information

A lack of transparency in tax devolution decisions can have long-term consequences:

1. Undermining Fiscal Federalism – States that manage their finances efficiently could feel penalized if they don’t understand why their tax share is shrinking.
2. Weakening Financial Stability – Unequal information access may create fiscal uncertainty, affecting state-level budget planning.
3. Hampering Public Trust – Without transparency, public confidence in tax transfers and Centre-state relations could deteriorate.

Path Forward: Transparency in the 16th Finance Commission

India has made strides in fiscal transparency, especially after signing the IMF’s Codes of Good Practices following the 1997 East Asian financial crisis. However, subnational fiscal transparency remains a challenge.

The 16th Finance Commission must:
✔ Enhance transparency in tax devolution formulae by clearly justifying changes.
✔ Launch a public finance data portal to centralize all Finance Commission-related statistics.
✔ Ensure accessibility of GSDP and tax transfer data, which currently remains restricted.

By addressing these concerns, the 16th Finance Commission can strengthen fiscal federalism and promote a more informed public discourse on tax devolution in India.