State vs state fights, on taxes

It will be interesting to see just how sensitive the 16th finance commission, which is in the process of being set up, will be to structural changes in the Indian economy. Indian governments have tended to turn a blind eye to several new dimensions of the economy, including widespread short-term migration from rural and urban areas. This has resulted in some unpleasant surprises to policy makers, especially the migrant crisis that resulted from the Covid lockdown. If the next finance commission ignores the interaction between short-term migration and the GST regime, it could distort the distribution of tax proceeds to states.When allocating tax proceeds across states, it has been the practice of finance commissions to rely quite heavily on Gross State Domestic Products (GSDP). This approach has its roots in the view that states can be treated as largely autonomous economic entities, with some having consistently higher GSDPs, others remaining laggards. Economic justice would then demand that the finance commission allocate tax proceeds in such a way that the rich states subsidise the poor. This approach has simplicity but ignores a peculiarity of India’s economic transformation.As has happened through history in the process of development, there’s been a shift in the composition of India’s GDP away from agriculture. Development theorists expect this shift to be accompanied by movement of labour away from agriculture, and, from rural to urban areas. Brazil and China have followed this pattern and seen substantial levels of urbanisation. medium105267267India, though, has not followed this pattern in entirety. Decline in the share of workers in agriculture hasn’t been met with a movement into urban areas to the same degree. High cost of living in metropolises has prevented workers quitting agriculture from migrating permanently into cities. Rural workers thus are left with the unenviable task of earning in cities while continuing to maintain families in their villages. They do so by taking up short-term work in the city while continuing to retain their village households.A consequence is that workers spend very little of their wages in cities and send home much of their earnings. It was the sense that their villages were home that made hundreds of thousands walk back, some for over 1,000km, to their villages during the Covid lockdown. Their preference for their village homes is also reflected in their expenditure patterns. The major share of their earnings is spent in their villages. To this end, they are willing to live in cities in conditions worse than what they are used to in their villages.The preference for spending in their villages rather than the city was evident in a survey conducted by the National Institute of Advanced Studies of short-term migrants working in Bengaluru’s construction industry. There is also evidence that some use their city earnings to influence power equations in the village.The earnings and expenditure pattern of short-term migrants has an informal effect on inter-state finances. Workers earn their livelihoods in states with high GSDPs but spend a major part of their income in their villages in states with much lower GSDPs. The task of improving living conditions of rural workers and their families in the lower GSDP states is thus being carried out, to some degree, by job opportunities in the higher GSDP states. This tendency is accentuated by the growing emphasis on GST.Being an indirect tax on commodities, GST collections are determined by the location where the commodities are bought. To the extent that workers spend their income in their villages, it is the lower GSDP states that benefit from GST collections. There is also the direct effect of workers’ expenditure in their villages on trade income in those states.There is thus an informal cross subsidy already at work before the finance commission steps into the picture. This has led some high GSDP states to demand that finance commissions take into account jobs these states provide to workers from low GSDP states. medium105267279Arriving at appropriate indicators of short-term migration will be difficult given the paucity of data. Census data on migration, cited in the 15th finance commission report, uses a definition of migration that doesn’t capture short-term migration. Appropriate data absent, there may be some difficulty in arriving at exact numbers of short-term migrants working in each state. But this is a limitation the finance commission should be able to overcome, if need be, by collecting necessary data.This data would need to recognise that migrant workers typically form identity-based networks in their villages. They then bargain with employers across different states to find the best opportunities for their workers’ group. The jobs they finally undertake can thus shift state to state. While the specific migrants employed in a state can change quite rapidly, overall levels of employment of short-term migrants would be an indicator of opportunities the state offers.It is possible to make a distinction between short-term migrants from the same state and those from other states. This would be a significant consideration in states like Karnataka with substantial regional inequalities within.Two additional elements then demand prominence to determine the share of states in tax proceeds. Employment provided to short-term migrants from outside the state would address the fact of high-growth states providing jobs for low-growth states. Employment provided to short-term migrants from within the state would dovetail into a larger case for providing employment a more prominent place in determining distribution of tax proceeds.The writer is dean of social sciences, National Institute of Advanced Studies, Bengaluru.