26/02/2015 2:26 PM IST | Updated 15/07/2016 8:25 AM IST

The Finance Commission Just Made Jaitley's Job A Little Harder

Handing over a greater amount of central taxes to states makes immense sense. Nevertheless, it makes things difficult for the central government. With the centre having to share more taxes with states, it leaves it with a lesser amount of money.

Hindustan Times via Getty Images
NEW DELHI, INDIA - FEBRUARY 19: Union Finance Minister Arun Jaitley during the launch of Central Services on eBiz Portal at National Media Centre on February 19, 2015 in New Delhi, India. eBiz portal is a government to business portal on which 11 central government services are available for the ease of doing business in the country by providing one-stop clearance platform for investment proposals. (Photo by Sonu Mehta/Hindustan Times via Getty Images)

The fourteenth finance commission led by former Reserve Bank of India (RBI) governor Y V Reddy, presented its recommendations a few days back. One of the major recommendations of the commission is that the states' share of central taxes be increased to 42%, from the current 32%.

As the report points out: "increasing the share of tax devolution to 42 per cent of the divisible pool would serve the twin objectives of increasing the flow of unconditional transfers to the states and yet leave appropriate fiscal space for the Union to carry out specific purpose transfers to the states."

Given that 'Cooperative federalism' is one of prime minister Narendra Modi's pet issues, it is not surprising that the government has accepted the recommendations of the Commission. Also, given that taxes are raised from states, it is only fair that a greater chunk of that money is handed over to them to be spent. Further, recent research also suggests that the gross domestic product (GDP) grows at a much faster rate when state governments spend money in comparison to when the central government does.

As Modi said in a letter to the chief ministers after accepting the recommendations of the Commission: "You will appreciate that, following the acceptance of the 14th FC recommendations, we are moving away from rigid centralised planning, forcing a 'One size fits all' approach on states."

Given these reasons, handing over a greater amount of central taxes to states makes immense sense. Nevertheless, it makes things difficult for the central government. With the centre having to share more taxes with states, it leaves it with a lesser amount of money.

As Modi put it in his letter to the chief ministers: "The 14th Finance Commission has recommended a record increase of 10% in the devolution of the divisible pool of resources to states. This compares with the marginal increases made by previous Finance Commissions. The total devolution to states in 2015-16 will be significantly higher than in 2014-15. This naturally leaves far less money with the Central Government."

And this is what will make finance minister Arun Jaitley's job far more difficult when he presents the budget on February 28. Taking the gross tax revenue number of the central government for 2013-2014 into consideration, the increase of states' share from 32% to 42% of central taxes would leave a gap of close to Rs 1,20,000 crore in the budget of the central government. In fact, the number for the financial year 2015-2016 (for which Jaitley is presenting the budget) would be higher than Rs 1,20,000 crore, simply because the gross tax revenue number would also be higher.

Long story short - Jaitley has a huge revenue gap to plug. He can look to plug some of this gap by going aggressive on the disinvestment front, especially cash in on the low hanging fruit. The stakes that the government holds in companies like ITC, Axis Bank and L&T through the Specified Undertaking of Unit Trust of India, is something that it can cash in on. The government ended up with shares in these companies after rescuing the investors of the Unit Trust of India in the early 2000s.

As of February 25, 2015, this stake in total was worth Rs 63,910 crore, and that should fill in close to half of the gap arising from the impact of accepting the recommendations of the Finance Commission. Of this, the stake in ITC was worth Rs 35,828.6 crore. The Axis Bank stake was worth Rs 12,890 crore and that in L&T was worth Rs 15,191.8 crore. For reasons best known to the government (both NDA and UPA) there has been a great reluctance in selling these shares.

The government also needs to start selling out/shutting down non-performing public sector units. The best example of this is Air India. The airline has been guzzling cash over the years. And this needs to stop. There is no reason that a government should be running an airline. It simply doesn't have the expertise.

Selling Air India and other such companies to a private companies (assuming someone is ready to buy them) will also lead to an increase in overall productivity of the nation. Of course, any plan to sell out Air India will be vociferously opposed by MPs, given that they will lose out on their free air travel.

But it's time that Jaitley and the Modi government rise above all this.