#20 Who Moved My State Finance Commission?
SFCs, New World Order, Sunset Rules, and Fuel Prices
This newsletter is really a weekly public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?
We are in a global public health emergency. I have no good ideas on managing it. So you won’t find anything directly related to the crisis itself here although I do talk about policy tools we need after the crisis is past us. #StaySafe
PolicyWTF: ‘Everyone Wants Decentralisation, But Only up to Their Own Level’
This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?
This quote, attributed to one of India’s most respected economists, Raja Chellaiah (1922-2009), comes to life while discussing this week’s PolicyWTF — the sorry state of State Finance Commissions.
Now, the Union Finance Commission has garnered a lot of attention in recent years. Its recommendation on sharing the tax divisible pool between the union and the states is keenly followed in policy circles. Historically too, successive Union Finance Commissions have made their mark as institutions of repute.
Similarly, after the 73rd and 74th amendments to the constitution (1992), each state was supposed to constitute a State Finance Commission (SFC) every five years to decide on sharing resources between the state and all its local governments. But I bet that you would have not heard about the deliberations and recommendations of your state’s own finance commission.
So here’s the story, courtesy an excellent NIPFP working paper by Manish Gupta and Pinaki Chakraborty:
By 2015-16, all states should have constituted their fifth SFC according to the constitutional terms. But turns out that only 13 states had done so, even by 2019.
The average delay in submitting recommendations for SFCs is 16 months!
The quantum of transfers devolved to all local bodies combined is extremely small. The all-state average recommended devolution as a per cent of states' own revenue receipts varies between 9.6 and 13.7 per cent in the period 2010-11 to 2018-19.
Unlike the Union Finance Commission, members of SFCs are often serving bureaucrats and politicians. This hampers its role as an autonomous body balancing the interests of both state and local governments.
If some SFCs recommend a larger quantum of devolution to local governments, these recommendations get summarily rejected by state governments.
One might argue that the original PolicyWTF here is the 73rd/74th amendment itself. These amendments left the devolution of funds and functions to local governments at the discretion of the state government. And public choice theory will tell you that no government wants to reduce its own powers. Hence we have enfeebled local governments. State governments want decentralisation from the union government but will do little to devolve their own functions and funds to local governments.
Under such conditions where local governments have little taxation powers, the role of SFCs becomes even more important. So the next time you crib about the potholes on your street or the erratic power supply, look up what your latest SFC is up to.
PS: One state stands out in terms of the quantum of its devolution to local bodies: Karnataka. As much as 40% of its own revenue receipts are devolved to local bodies. Perhaps there is a ‘Karnataka Model of Governance’ here.
A Framework a Week: Sunset Clauses
Tools for thinking public policy
In these difficult times, governments across the world are taking several measures to restrict movements of goods, services, labour, and capital. Restrictions of this kind are inertial; they tend to linger around way longer than they are needed for. So a public policy tool that can be helpful in countering this inertia once we are out of the public health emergency is sunset rules.
Sunset rules essentially require that programs and/or regulations need to be reauthorised periodically. The default is that the sun sets on them after a period of time; they die.
Surya Prakash BS has an excellent explainer on sunset clauses in the Mint. Apart from overcoming inertia, he argues that this tool institutionalises balancing feedback through periodic revisions:
By allowing specific time periods for the operation of laws, this tool could allow policymakers to push for new ideas to be implemented with limited downside. Similarly, those opposing the changes should insist on including such a clause to ensure evaluation of policy intervention. This requires an admission that modern law making is experimental in nature and requires validation by results. This assumes even more importance in the Indian context where the parties in power could swing widely, leading to either implementation of unviable electoral promises or mindless reversal of laws passed by previous government. Having a fixed tenure for review in effect may actually ensure certainty of law.
For more on this tool, here’s a paper.
Matsyanyaaya: COVID-19 and the New World Order
Big fish eating small fish = Foreign Policy in action
There are lots of articles on how COVID-19 outbreak could shape the world order. Kurt Campbell and Rush Doshi have a good article in Foreign Affairs which lays out how China is manoeuvring for international leadership while the US legitimacy is taking several hits.
Our own New World Order Framework suggests that some scenarios are becoming more likely than others.
In edition #12 of this newsletter, I had argued that by 2016, we had entered The Great Walls scenario where the political differences between the US and China seemed structural and long-term while the geoeconomic trends appeared to be lacklustre.
That seems like an optimistic scenario now. We seem to be heading towards a ‘Race to the Bottom’ scenario — at the intersection of cold US-China relations politically and a global recession economically.
How would this world look like exactly? Here’s an attempt that our team made two years ago:
TL;DR: this scenario restricts India’s options. It further constrains India’s path for accumulating economic power, the power on which all other forms of power rest.
India Policy Watch: Derangement of Fuel Prices
Insights on burning policy issues in India
If you didn’t follow Lok Sabha debates last week, you might be surprised to know that the amendment to get enabling powers to raise excise duty on petrol and diesel by ₹8 per litre each in future was passed without debate. This comes just a few days after the government raised excise duties on petrol and diesel by ₹3 a litre.
All this happened even as global prices of crude oil fell by over 45% this month alone. After India transitioned to market-determined pricing for petrol and diesel, such a drastic drop should have resulted in a much lower price to the Indian consumer as well. But the Indian way of “market-determined price” only has one beneficiary: the government.
The playbook is this: whenever governments face a resource crunch, they will increase the excise duties on petrol and diesel. Even better if the global crude oil prices are low, the consumer price can be kept at the same levels while the government can mop more funds by increasing excise duty.
What explains the complete lack of opposition to this theft by governments? Wilson’s Matrix provides some perspective: the benefits accrued from opposing government’s move to raise prices are far too dispersed. Anchoring Effect and Declinism Biases might also be playing a role here: who amongst us expects petrol prices to fall; ‘things always get only costlier, isn’t it’?
Nevertheless, this theft by the government has really high opportunity costs. Uttam Gupta in a Financial Express op-ed lays this out quite well:
The Centre and states may have reason to rejoice, but this imposes prohibitive costs on the economy, contributing to high fuel price (even when crude price declines), high inflation, higher subsidy payments on fertilisers, food, irrigation, etc, and undermining the competitiveness of Indian goods in the international market. No wonder, a good slice of revenue from fuel taxes is offset by an increase in subsidy payments and revenue foregone from sectors where growth is constricted by high fuel price.
The point about high fuel excise duties also leading to a higher subsidy bill was fascinating.
State governments aren’t far behind in this theft either:
Yet, in their obsession to extract more, states have taken recourse to bizarre methods of taxing the fuel sector. Thus, even as Telangana charges high VAT (35.2%) on petrol, Uttar Pradesh (UP), which has a somewhat lower ad valorem rate of 26.8%, also has a ‘specific’ rate of Rs 16.74/litre, with a rider that the higher of the two will be applicable. This means that when international price drops, the specific rate is triggered, thereby protecting state’s revenue. West Bengal, Uttarakhand, Assam, Haryana, Himachal Pradesh, and Jharkhand have a similar taxation system as UP’s.
The downstream consequences of this derangement of fuel prices needs a lot more study.
HomeWork
Reading and listening recommendations on public policy matters
[Article] Ajay Shah writes that a combination of public funding and private production of testing and healthcare is critical for an adept Indian response to the epidemic.
[Book] Economic Fables by Ariel Rubenstein is a wonderful introduction to game theory.
[Paper] I am exploring the relevance of systems thinking in visualising general equilibrium conditions so that we can analyse public policies better. This OECD paper has some good examples.
[Course] If you’re locked up at home and looking to start learning something new, this old course Model Thinking by Scott Page is a good place to start. It will equip you with models, many of which apply to public policymaking.
[Video] I think Jaspal Bhatti’s Flop Show is an underrated method for public policy learning in the Indian context. This episode on telephone connections for example brilliantly illustrates the complications that arise in transaction-intensive and discretion-intensive tasks such as administering government-regulated telephones.
That’s all for the week. If you like this newsletter, please do read and share.