More climate change variables needed in 16th Finance Commission’s tax distribution formula, say experts

More climate change variables needed in 16th Finance Commission’s tax distribution formula, say experts

Subject: Polity

Section: Federalism

Context:

• The 16th Finance Commission which will be constituted in November will give a formula for tax distribution among states for the period 2026 to 2031.

Details:

• The formula-based finance commission transfers are unconditional and are not tied to the department of Forest or Ecology.
• The last two Finance Commissions (14 & 15th) focused solely on forest cover within the climate change criterion that was incorporated into the Terms of Reference (TOR) for the 13th FC.
• Some of the other variables that may be considered are: Biodiversity, Ecosystem services etc. among others.

Need for including more variables:

• It could increase the incentive to protect and restore forests or direct conservation toward certain types of forests.
• Global practices of environmental fund allocation:
  • The Brazilian state of Para allocates funds based on deforestation reduction.
  • The Brazilian state of Tocantins and the Indonesian province of North Kalimantan allocate funds based on forest fire control.

Concerns in including more variables:

• Adding other factors may make the formula complex and tough to measure.
• There is a possibility that monoculture is promoted as forest.
• Whether ecological variables, such as forest cover, in the tax distribution formula under the Finance Commissions, have any impact on the environment and its conservation in the states, is, as yet, unclear.
• The environmental funds allocation from FC is unconditional meaning it is not clear whether they are being used for environmental purposes or not.
• Since 2005, the central government has been sharing annual forest grants to states which are intended both as compensation mechanisms and incentive mechanisms, it remains unclear how much the grants for forests have contributed to increased forest cover in the states.

Some studies indicates:

• No significant change in the state’s forestry budget despite the fact that they received incentives (through EFT) for maintaining land under forest.
• States with high forest cover experienced a loss of forested acreage, while states with lower initial cover gained forested land.
• States receiving a larger share of compensatory funds through CAMPA had a higher percentage of forest land diverted to non-forest lands.

Finance Commission:

• The Finance Commission is a Constitutionally mandated body that is at the center of fiscal federalism. Set up under Article 280 of the Constitution, its core responsibility is to evaluate the state of finances of the Union and State Governments, recommend the sharing of taxes between them, lay down the principles determining the distribution of these taxes among States.

Finance commission’s tax devolution formula:

• The Finance Commission’s formulae for tax sharing have evolved since the first one, constituted in 1951, for the period 1952-1957.
• Since then, FCs have been constituted at intervals of every five years with the 15th one currently being implemented and the 16th FC, to be constituted in November and applicable starting next year.

Tax devolution:

• States’ share at 41 percent of the divisible pool comes to 42.2 lakh crore for 2021-26 period.
• Based on principles of need, equity and performance, the overall devolution formula is as follows:

Changes in horizontal devolution:

• The formula for distributing tax among states respectively is known as horizontal devolution.
• 7th FC drastically reduced the weightage of ‘Population’ criteria from 80-90% to 25%, and increased the weightage of other indicators related to equity, in which income, land area, and sometimes infrastructure and fiscal discipline are also considered.
• Changes in determining the funds allocation for environmental initiatives:
  • The 12th and 13th FCs (covered the period from 2005 to 2015) gave specific-purpose grants to states, for forestry, amounting to Rs. 10 billion and Rs. 50 billion, respectively but these grants comprised less than 0.05% of the total funds transferred from the central government to the states.
• Ecological Fiscal Transfers (EFT):
  • Introduced in 2015.
  • Under the EFT public revenue is shared based on ecological indicators.
  • The 14th FC incorporated forest cover as a criterion for tax devolution, allocating it a weightage of 7.5% in the distribution formula for the tax transfer during the period 2015-16 to 2019-2020.
  • The 15th FC retained the variable of forest cover for tax distribution, increasing the weightage to 10%.
  • EFT has significantly increased globally, from $0.35 billion in 2007 to $23 billion in 2020, spanning countries like Brazil, Portugal, France, China, and India.
  • EFT had not led to a noticeable increase in forest cover or state forestry budgets

Source: Mongabay