In February 2015, the Government of India accepted the Fourteenth Finance Commission’s (FFC) recommendation to empower states with greater expenditure discretion. The states’ share in Union taxes, therefore, increased from 32% to 42%. While the move holds the promise to reform India’s centralized, one-size-fits-all approach to financing the social sector, the process adopted by the government raised several concerns.

First, the government, in its 2015 budget, significantly reduced funding to states through plan transfers—the primary instrument for financing social sector schemes. From the centre’s perspective, this was necessary to create the fiscal space to increase states’ share in Union taxes or to enhance untied funds. However, many observers and state government officials argued that the gains of devolution were offset by cuts in plan budgets, leaving states with less rather than more money. A second concern was how state governments would respond to these changes? Will states in fact use their untied money to enhance social sector expenditure?

So what has really changed? To answer these questions we analysed 13 budgets across a wide cross-section of states, including Bihar (which is greatly dependent on union finances), to relatively better off states such as Maharashtra and Tamil Nadu. The sample is thus broadly representative of trends across the country. Here are some highlights.

But first, two important methodological constraints. Most state governments were completely unprepared for the changes—some had even passed their budget before Government of India accepted the FFC recommendations. As a result, a number of them are yet to reconcile their budgets to reflect the new transfer system. Further, most states had under-budgeted expenditure on centrally sponsored schemes (CSS)—since the changed funding pattern was finalized in October. While some of this was rectified by passing supplementary budgets, not all of these are available in the public domain. A comprehensive analysis will only be possible in 2016-17.

For our analysis, we have only focused on those states where supplementary budgets were available. Thus, trends reported here are only indicative. Second, revised estimates (RE) for 2015-16, which reflect the actual picture of government spending, are not yet available. Thus, our analysis for 2015-16 is a reflection of government intention rather than actual expenditure. Historically, there have been large gaps between budget estimates (BE) and RE.

To what extent has the fiscal space changed? As highlighted in the tables accompanying this article, tax devolution along with finance commission grants significantly expanded untied funds available to states. Bihar, Himachal Pradesh, Andhra Pradesh, Chhattisgarh, Jammu and Kashmir and Kerala are some states where the overall untied revenue pool increased significantly, compared with 2014-15 (RE). But many of these states also lost a significant amount of money through cuts in plan schemes. Jammu and Kashmir, Himachal Pradesh and Bihar were the biggest losers, with the share of funding through CSS reducing sharply.

But here is the good news. If we compare the overall revenue received by states from the Union (including untied and tied funds), most states have ended up receiving either the same or significantly more money from the Union in 2015-16. The biggest gains were made in Chhattisgarh (19%), Rajasthan (12%), Kerala (32%) and Himachal Pradesh (33%) if we compare 2014-15 RE with 2015-16 BE. These numbers however change if we compare this year’s BE with intended devolution in 2014-15 (BE). Rajasthan and Bihar, for instance, see a decrease in Union funding. It is important to note that Union transfers fell mainly in fiscally stronger states, such as Maharashtra and Karnataka. Given this, it would be fair to argue that despite states receiving fewer resources from the union through schemes and grants, most states have enough resources in 2015-16 to, at a minimum, maintain social sector expenditure at the same level as 2014-15.

But, did they? How have states responded to their newfound fiscal autonomy? Are there any visible shifts in social sector expenditures at the state level? Overall, we find that social sector investments have in fact increased across all states, except Bihar. The extent of the increase varied: Chhattisgarh, Jharkhand and Maharashtra increased expenditure by more than 25% (BE and RE) and Bihar dropped expenditure by just under 2% (if we compare RE to BE).

However, the scenario changes when viewed from the perspective of social sector as a proportion of total spending across all sectors. Many states, like Bihar, Maharashtra and Karnataka, have seen a significant reduction in social sector investments as a share of total expenditure while others, like Rajasthan and Uttarakhand, have increased their proportional investments from last year.

This year has seen signs that states are using their flexibility by shifting priorities within the social sector. Karnataka, for instance, reduced its revenue expenditure on “education" by 11% (BE and RE) while increasing its investments in “housing" by over 50% (BE and RE).

In summary, while the FFC was designed to enable a radical restructuring in states’ finances in the country, for the moment, the changes we see are modest. For the moment, states have more or less the same quantum of resources available to them as they did in the previous year. This should lay to rest fears that the FFC has resulted in a fiscal squeeze—until we have the revised estimates.

But, at the same time, despite increases in untied funds, states are yet to demonstrate any serious attempt to restructure their budgets in a way that reflects their new-found autonomy to alter investment patterns.

Is this a tectonic change or a lost opportunity? Only time will tell.

Avani Kapur and Vikram Srinivas are researchers with Accountability Initiative, part of the Delhi-based part think-tank Centre for Policy Research.

Graphics by Ahmed Raza Khan/Mint.

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