(FC) goes about making recommendations as to how much of the aggregate revenue collected by GoI should be devolved to the states and how the collective share of the states should be distributed among the states, it would be useful to study the treatment received by Kerala at the hands of the 15th Finance Commission (FFC) as a cautionary tale.But, first, let us dispel the misperception that FC awards are handouts from GoI to the states. Taxes belong to the people of India. Different taxes are collected by different levels of the government, depending on which level can collect the tax most efficiently. Just because the tax on incomes, whether of individuals or companies, is collected by GoI, it does not follow that these are GoI's taxes. Corporate incomes and a good deal of personal incomes are derived from economic activity spread all over the country, facilitated by central and state governments.
Just because a good many companies are headquartered in Mumbai, it does not mean they derive their income from that city or Maharashtra. If Kerala were to lay claim to all the customs duty collected at the Vizhinjam port, other states and GoI would cry foul. Such taxes are best collected by GoI and shared with the states.
Kerala has been an outlier, in terms of social development, and the formula used by FFC, designed to address backwardness among states, has been less than fair to Kerala. In fact, the FFC award has been less than fair to other southern states, too. The share of total devolutions each of these states receives has been below its population share: 30% below the population share in the case of Tamil Nadu and Kerala, and 28% below the population share in the case of Karnataka and Telangana.
Backwardness has to be cured, sure, but the most effective medicine is better governance. Shovelling more funds taken from relatively better-governed states to inefficient governments that leak funds is a recipe for enriching regional kleptocracies, not for removing backwardness. The 16th FC should give much greater weight to indicators of governance, in the devolution formula. FFC gave a minuscule 2.5% to a state's tax effort. This should rise to at least 15%. Introduce a weightage for development expenditure. Reduce the weightage for income distance.
Poverty is a special need, of underdevelopment. A large proportion of old people is a special need, arising from development that increases the lifespan. Kerala has the highest proportion of the population aged 60+, according to Elderly in India, a GoI publication: 16.5%, double the level in UP. FFC's approach not only failed to provide for such needs, but curtailed funds that could be used for old-age pensions and extra healthcare.India is the world's largest recipient of worker remittances from abroad, $129 bn in 2024. Different states make different contributions to these receipts of scarce forex. State expenditure on building exportable skills and talent results in these remittances. Why does it not make sense to introduce weightage, in the devolution formula for state contributions to remittances?The 16th FC would do well to contain the devolution award of any state within 10% of its population share. States should not be deprived of their fair share of the nation's resources because they make good use of what they receive. Its obverse is that states should not be rewarded for governance failure.
It would do well to include all cesses and other levies on income and wealth in the divisible pool. At present, GoI devolves only 32-33% of its tax collections, rather than 41% as prescribed, because it dresses up some duties and levies as cess and surcharge, which are not shared with the states. A good portion of the levies on petro fuels is cornered by GoI via this subterfuge.
How is GoI to find the resources needed for defence, you might ask, if such cesses are also made shareable. By withdrawing its imperial expansion to state subjects such as healthcare and school education. Using central funds to paint the PM's picture on school walls diverts funds that should fund defence projects or go to the states, which bear the bulk of development expenditure.
However, only a part of Kerala's problems can be blamed on skewed federal finance in India. The bulk of the problem is internal, generated by the state's politics, which have been hostile to capitalist prosperity.
That is changing now, with ministers of the Left government hailing Adani as a partner. Political parties must educate their student, youth and worker organisations to value and promote entrepreneurship, to respect and encourage honest failure, revising entrenched attitudes to risk.
Kerala has a growing startup community, which must be helped to grow, establishing linkages with educational institutions and established industry that is averse to in-house R&D.
Kerala's Communists organised successful cooperatives that sported brands such as Dinesh Beedi and Indian Coffee House. Why not bring that nous to bear on electronic assembly? Electronic component manufacturing is waiting to take off in India to replace suspect foreign components in infrastructure and defence, and innovate new capabilities.
Encourage young engineering graduates to grab this opportunity instead of migrating to AI-threatened software or flaky Trumpland.
It is time for Kerala to convert its vaunted social development into Asian- Tigerish success, shedding inhibitions about capitalist growth.
