Aiming for cooperative federalism, govt created Centre-states mistrust

A recent charge by Kerala that the Centre is violating Constitutional provisions to encroach into the financial powers of the states is yet another instance of the states fearing that the federal structure of India is being compromised.

There is no love lost between the Centre and the states, particularly those ruled by the Opposition parties on various issues. They are already up in arms over ending the GST compensation to the states from this month onwards. Earlier states and the Centre locked horns over proposed rules by the Centre about the transfer of bureaucrats, tax cuts on fuels, agriculture laws etc.

All this is happening when the National Democratic Alliance (NDA) government at the Centre had promised to bring in cooperative federalism.

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Last month, Kerala Finance Minister K N Balagopal shot off a letter to Union Finance Minister Nirmala Sitharaman alleging that the Centre has bypassed the Constitution by including public account liabilities of the states and borrowings of state Public Sector Undertakings (PSUs) in the state's net borrowings to limit them to 3.5-4 per cent of their respective gross state domestic product (GSDP) for 2022-23.  

Balagopal blamed the union finance ministry for putting it in a grave financial crisis by slashing its resources by Rs 23,000 crore in the current financial year.

“The Centre has done so by reducing revenue deficit grants, ending GST compensation from July onwards, and factoring in borrowings by the state entities and public account liability while fixing borrowing limits of Kerala and other states”, Balagopal said.  

The state FM said the Centre has reduced the revenue deficit grant of the state to the tune of around Rs 7,000 crore this year. Besides, the end of the GST compensation from July onwards will make the state lose another Rs 12,000 crore. On top of that, the union finance ministry, in the name of off-budget borrowing, made a reduction of approximately Rs 4,000 crore in the net borrowing limits of the state.

The letter by Balagopal argued that liabilities of state instrumentalities, like statutory bodies and companies, do not come within the definition of state debt.

However, on July 25, FM Sitharaman, in a written reply in the Lok Sabha, said that borrowing by state public sector undertakings or their special purpose vehicles (SPVs) will be considered as borrowing by the state government needing consent.

Balagopal, on the other hand, said this clearly violates the Constitution. He also highlighted that the Centre does not do so in case of its own borrowing.

He charged that under the declared objective of fixing the net borrowing ceiling, Article 293(3) of the Constitution is being used to vitiate the state's independence and make systematic inroads into the financial autonomy of state governments, enshrined in our Constitution.

Article 293(1) deals with the executive power of a state to borrow within the territory of India upon the security of the Consolidated Fund of the State, and the Legislature of such state by law is empowered to fix the limit. Article 293 (2) enables the Centre to make loans to any state so long as any limits set under Article 292 are not exceeded.

Article 293(3) of the Constitution fetters the state's power to raise loans. Under this provision, if there is still any part of a loan made to the state by the Centre or in respect of which the Centre has given a guarantee, the state concerned is forbidden from raising any loan without the consent of the union government.

Balagopal said the requirement that a state must obtain consent under clause (3) of Article 293 of the Constitution is applicable only when a state is either indebted to the Centre, or when the repayment of a loan taken by the state that the Centre has guaranteed remains outstanding. This implies that the purpose of this provision in the Constitution is to protect the rights of the Centre in its capacity as a creditor.

"Clearly, therefore, the conditions under clause (4) of Article 293 must necessarily be directly related to the specific loan for which the Government of India issues consent under clause (3) of Article 293. In other words, using Article 293(3) and (4) of the Constitution to regulate and oversee the financial management of the state governments and their agencies is far beyond what is contemplated in the Constitution," he said

He said for over seven decades after the Constitution was enacted, successive governments at the Centre have always adhered to the constitutional provisions respecting the financial powers vested with the state governments to manage their affairs.

"In August 2017, Article 293 (3) was wrongly and unconstitutionally administered to significantly constrain the financial freedom of State Governments. That year vide letter No. 40(6) PF-1/2009-Vol III dated 28th August 2017; the Government of India decided to effectively include the balances in the Public Account of the State while reckoning the Net Borrowing Ceiling of the State Government," he said.

He said Article 293(3) can only be legitimately used for imposing conditions related to a request for borrowing of a state government. "This cannot be used to control or administer the borrowing of the state government. Under the Constitution, these are matters that exclusively remain in the domain of the state government," Balagopal said.

Thus clearly, even if for argument's sake, conditions under Article 293(3) were to be made in general on the overall annual borrowing programme of states, this could at most apply to the state's share of Open Market Borrowings and the borrowings from central PSUs and financial institutions like LIC, Nabard etc, which are regulated administratively by the Centre or are a necessary part of the monetary policy of the Centre, he said.

"It is not difficult to see that such conditions cannot go beyond and be used to control and regulate the exercise of the state's financial powers itself," Balagopal emphasised.

Generally, states are allowed to borrow up to three per cent of the respective GSDP.  However, this limit has been raised from 2020-21 due to lockdowns induced by Covid-19. For the current financial year, states are allowed borrowing to 3.5 per cent of their respective GSDP unconditionally. Another 0.5 percentage point borrowing is allowed under certain conditions that the state has to meet such as power sector reforms.

This is not the only area where a state or states, particularly those ruled by the Opposition parties, have voiced concern over their relations with the Centre.

GST compensation to the states

States are miffed at the Centre for not extending compensation to them beyond June this year in case they do not record annual 14 per cent growth in the GST collections on the base year of 2015-16. However, GST compensation for the first five years of the GST rollout was legitimised under the Compensation Act, enacted with the consultation of the Opposition parties. The five years ended on June 30, 2022. Any amendment to this Act could be made through a decision of the GST Council, a body where the Centre and the states have representations, though the union government enjoys virtual veto power.

The Council had extended compensation cess, through which compensation to the states was made, till March 31, 2026. However, this would now be used to repay the debt that the Centre raised on behalf of the states to pay them compensation when their financial condition turned weak due to Covid-induced lockdowns.

Though the issue of extending compensation to the states was expected in the Chandigarh meeting of the GST Council in June, the issue was not taken up there and is likely to figure in the next meeting.

Taxes on fuels

Prime Minister Narendra Modi in April named seven Opposition-ruled states that did not cut their value-added tax (VAT) and sales tax on petrol and diesel even as the Centre slashed the excise duties on them. He particularly named Maharashtra, West Bengal, Telangana, Andhra Pradesh, Tamil Nadu, Kerala, and Jharkhand and did not reduce VAT despite the high international prices of crude.

The Opposition-ruled states criticised this statement as encroachment by the Centre on their rights. They argued that they would reduce tax rates on petrol and diesel if the Centre cleared their dues. While there were differences in the estimates of total dues that the Centre owed to the states, the former cleared all the compensation to the latter despite some delay earlier.

The Central and state-level taxes contribute about 55 per cent of the retail price of petrol and 51 per cent for diesel. Apart from the taxes, fuel prices include freight charges and the dealer commission.

Tamil Nadu's decision on advisory council

In April, the Tamil Nadu government had set up an advisory council on the fiscal powers of the state and the Centre with special reference to the GST, a move that has triggered the fear of fissures between the Centre and states if others follow suit.

Many of its terms of reference may undermine the GST Council, say experts. For instance, the council, chaired by senior advocate Arvind P Datar, has also been tasked to identify the problems with the institutional mechanisms that support GST, which include the independence of decision-makers and the constitution of the GST Tribunal.

The body would also identify difficulties with respect to GST rates applied to various commodities. The council has been asked to suggest strategies to improve GST collections and other taxes of the state. It would also study the best practices adopted in other states with respect to GST, including the use of technology and artificial intelligence to identify tax evasion.

One of the terms of reference says the body would study the levy of cesses and surcharges by the Centre and its impact on the state's finances.

An expert said the fact that one state is constituting a committee on various aspects of GST means that fissures between the state and the Centre in GST are now increasing. “GST reforms are done by the GST Council and groups of ministers appointed. Here we are seeing a state appointing a team to get into what should be done,” he said. Another expert said that if other states follow suit, it is going to become difficult for the GST Council to decide on the next stage of reforms.

“During the VAT regime, this used to happen as VAT laws were different in each state. They were pulling in different directions. After GST came, there was some unanimity since the Council has both the Centre and the states. Now, if each state starts making its own team and its own recommendations, it is going to become very difficult for GST from a policy point of view,” he said.

However, the next GST Council meeting, which happened in June did take the decisions unanimously including imposing GST on pre-packaged food items irrespective of the fact whether they are branded or not.

Agriculture laws

Though scrapped now, the three farm laws passed by Parliament had fuelled tension between the Centre and the states. One major criticism of the three laws — the trade Act, the contract farming Act, and amendments to the Essential Commodities Act — is that they allegedly infringe upon states’ rights.

Particularly the trade Act, which regulates out-of-mandi transactions and lays down that states won’t be allowed to charge any fee on such deals, was criticised by states as a gross violation of their constitutional rights.

This is not all. During Covid days when the issue of migrants flared up, the prime minister had accused the Opposition governments of instigating migrants to leave and escalating the spread of infection. This had set off a confrontation between the Centre and states at that time.

While Delhi Chief Minister Arvind Kejriwal had described Modi’s statement as an outright lie, ministers in the then Maha Vikas Aghadi government in Maharashtra had said the Prime Minister was distorting reality with an eye on elections in five states.  Uttar Pradesh, Punjab, Goa, Uttarakhand and Manipur went to the polls in March this year.