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Fiscal Federalism Must Now Include Resource Federalism

Ignoring the resource federalism is causing a systemic political stress that is now threatening the institutionalised democratic set up

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This institutional structure of fiscal federalism was designed at a time when the Union government was the principal driver of development through public investment. In the planned economy with quantitative controls, fiscal policy was geared to finance investment by raising the level of domestic savings, and transfer household savings to public investment. This had a major impact on the operation of fiscal federal system.    

 As an institution of federalism, the Finance Commission was set up to redress the vertical imbalance in governmental finances and to ensure horizontal equalisation of public services though revenue sharing and fiscal decentralisation.

Seven decades later, the situation is radically different. We are not operating in a closed and control economy but in regulated open economy. It is no longer public investment, but private investment that is driving development helped by a liberalised domestic and foreign investment regime.  

In the markets-led growth paradigm, natural resources are fast becoming the key revenue drivers for, and major constraints to macroeconomic growth and its spread across the sub-national economies. This change necessitates a change in the design of fiscal federalism.  
 
As far as resources are concerned, the State government don’t have any elbow room. For instance, instead of restructuring the minerals sector along market lines, the  amendments to the “Mines and Minerals (Development and Regulation) Act, 1957”, has restricted States from exercising the powers of State Governments even though the owners of minerals located within their respective boundaries. The Central government also extracts substantial share of revenue directly and indirectly from these resources. If this wasn’t enough, the Central government undertakings being the biggest consumers of minerals are an additional source of revenue for the Centre! So, the distribution of revenues from natural resources is effectively 50:50. In other words, the Centre corners half of the revenues generated from natural resources.

In the current system, resource aspect is peripheral if not absent from the scheme of federal transfers. This must change. The real challenge going forward is to design a framework for “resource revenue” sharing in addition to the “transactional revenue” sharing that has been  traditionally been done so far. In other words, fiscal federalism must be now be linked to resource federalism in India. This framework can start with a fair scheme for distribution of resource rents, but it must graduate towards a more robust and institutionalised system of resource federalism. In doing so, we would have aligned the existing fiscal federal set up to work in an open but regulated market economy as against a closed controlled one, the vestiges of which remain in this segment of the economy. One of the criteria for the quantum of statutory of transfers should be the contribution of a region to the development of natural resources.

To start with, revise and restructure the royalty system which, at present, is an ad hoc mix of unit-based and ad valorem-based approaches. A move towards a non-discretionary and automatic system of indexed ad valorem rates that moves in line with the price movements commodity markets needs to be made. It is quite anomalous that coal, which accounts for the largest share of royalty revenue, rates have been revised only 4-5 times since the nationalisation of the industry in the early 1970s.  

Ignoring the resource federalism is causing a systemic political stress that is now threatening the institutionalised democratic set up. It would be naive to attribute the current political turmoil, for instance, to administrative or political corruption alone. The roots of a number of scams originate in the resource conflict between the Centre (and its associates) and States (and their associates).

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.


Haseeb Drabu

The author is Former finance minister, J&K

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