Give money to states: The single most effective thing Modi could do to fight Covid-19

The Union government has done a lot since India started to fight the Coronavirus disease – including putting in place the world’s harshest lockdown.

However, it might have missed a low hanging fruit that might be more effective than any single other thing it can do: provide more money to the states.

To understand why, it bears going over the structure of Indian federalism. Continuing from the British Raj, the Indian Constitution grants vast financial power to the Centre. Most taxes are collected by New Delhi. However, most of the work of governance is done by the states. To sum it up in the pithy words of the late KC Sivaramakrishnan, bureaucrat and former chairman of the Delhi-based thinktank Centre for Policy Research, “Centre deals with files, State deals with lives”.

This is rather apparent in a health emergency like the coronavirus. Both health and law and order fall completely under the states. So almost anything to do with Covid-19 – be it treating patients or enforcing a lockdown – has to actually be carried out by the states.

Unfortunately, India’s federal fiscal framework has always been a handicap in this regard. The recent Finance Commission report, for example, transferred just 41% of taxes collected by the Centre for the year 2020-‘21. The real figure, it might be noted, is even lower since the Centre does not allow some taxes to be shared by labeling them as either cesses or surcharges.

This means states are always short on money – privation that has reached emergency levels with the lockdown, with even the meager source of the state’s own income now shut. As West Bengal Chief Minister Mamata Banerjee put it laconically on Friday, “Kono earning nei, shudhu burning.” We are only burning [cash], not earning.

Diverse union

As a way to combat the crisis, for its part, the Union government has released a welfare package. But that is simply not enough. For one, as earlier pointed out, the states are on the frontline battling the coronavirus outbreak. It is vital to support them if India’s battle against the pandemic has to succeed. Second, central schemes do no allow for the wide variations in state needs. Just on health, the needs of say Odisha versus Karnataka are vastly different.

As a result, three demands have emerged which could allows the Union government to directly help the states financially at this time of crisis:

1. Clear state dues

This is the most obvious. And in fact, should not even need a crisis. The Union government is sitting on money it owes to the states. This is as part of the Goods and Services Tax compensation. This is money owed to states to help them bridge the shortfall between the new GST introduced by the Modi government in 2017 and the old tax collection regime. Since the new Goods and Services Tax has performed poorly compared to the older system, this is a significant amount.

The last time Prime Minister Modi had a meeting with with the state governments, on Friday, the states demanded that the GST compensation the Centre was holding back be cleared. So strident was this demand that even Bharatiya Janata Party states chimed in – a rare example of ministers breaking party ranks to represent their state’s interests.

Gujarat flagged that New Delhi owed it Rs 7-8,000 crore as part of GST Compensation. The figure for West Bengal was Rs 2,875 crore. Punjab has written to the Modi government asking for Rs 6,725 to be cleared. Kerala has even threatened to move the Supreme Court to force the Union government to pay what it owes the states.

As of March, New Delhi owes the states Rs 30,000 crore by way of GST compensation. To put that in perspective, this by itself is nearly a fifth of the entire Central Covid-19 welfare scheme offered so far under the Pradhan Mantri Garib Kalyan Yojana.

2. Allow states to borrow more

States in India are generally more fiscally prudent than the Union government. All through the past decade, in fact, states have run smaller fiscal deficits (the gap between expenditure and revenue) than New Delhi.

While this might seem like a good thing at first glance, it has significant downsides. Since states have small revenues to begin with, to keep deficits low, they cut back on expenditure. Given their outsized governance role, this is unfortunate even during normal times. But during a health emergency, this is disastrous, given that states are doing most of the work to battle Covid-19.

States in India cannot decide their own fiscal deficits – that is capped by a Union law known as the Fiscal Responsibility and Budget Management Act. As a result, multiple states have asked the Centre to raise the fiscal deficit limit from the current 3%. While Bihar (a state where the BJP is part of the ruling coalition) as well as Kerala have asked for it to be raised to 4%, West Bengal and Rajasthan want it to be 5%.

3. Simply give states money

Neither of the earlier two measures involve the Union government actually dipping into its coffers for Covid-19. The first was a transfer of money already owed and the second was just a change in rules to allow the states to borrow more – money that the states would have to repay at a future date.

Given the scale of the crisis, this is unusual. The Centre will itself need to hand over money to the states to help them in their work against the pandemic. The demand for this has taken the form of an untied grant. This would not only boost the state’s coffers, unlike a Centrally-designed scheme, it would allow each state to spend as per their own requirements. Given the Indian Union’s vast diversity when it comes to health, this is critical.

States have themselves made this demand to New Delhi. West Bengal has claimed Rs 25,000 crore while Rajasthan’s has quoted a figure four times that amount: Rs one lakh crore.

Yamini Aiyar, president and chief executive of the Delhi-based thinktank Centre for Policy Research explained why this would be such an effective tool to fight Covid-19: “Rather than the the Pradhan Mantri Garib Kalyan Yojna, it would have been far more helpful to provide a stimulus package as an united block grant to the states,” she explained. “The needs of each state in this crisis are different, so rather than impose spending patterns, the states need to be allowed to spend as they see fit given they are on the frontlines.”