Duly elected state governments must have the right to frame their own policies but they also need to be able to fund their programmes and be accountable
March 21, 2023
Government employees hold a demonstration in Mumbai demanding implementation of Old Pension Scheme in the state. (Express photo by Ganesh Shirsekar)
Most parents would acknowledge that the teenage years are the toughest phase of parenting. The new adult mind of the teenager wants to break free and make independent decisions but is restrained by the continued financial dependence on parents. India’s federalism between the Union government and states is now at a similar stage.
Nearly eight decades after the formation of the Republic, India’s states have matured and want to make their own decisions such as the type of pension scheme to adopt for their workers, how their universities should admit students, the freedom to decide welfare programmes and so on. But the problem is that states neither have the financial resources to implement their decisions nor the freedom to mobilise finances on their own. They are thus independent to make policies but are dependent on the Centre for resources, resulting in a “parent-teenager” quandary. The current standoff between the Union government and states over various issues such as “freebies” versus welfare, reversion to the old pension scheme, imposition of conditions for financial grants on states and so on are all manifestations of this syndrome of “freedom without finances”. The recent brouhaha over the old versus new pension scheme is a classic example.
States such as Rajasthan, Punjab, Himachal Pradesh, Chhattisgarh, Jharkhand and Bengal want to implement the old pension scheme (OPS) that pays government workers a fixed amount post-retirement but increases the state’s financial burden over the long run. The Centre opposes this because they have to provide the financial resources eventually. The states are right in claiming that they have the power to decide the type of pension scheme for their employees. But they do not have the money. Given a choice, most government workers across all states will opt for OPS. But large states such as Maharashtra, Tamil Nadu, Karnataka and Gujarat are resisting pressure from their government employees to revert to OPS because of its dangerous financial implications.
Paradoxically, states that want to implement OPS have much higher debt levels (40 per cent of GDP) than the states that are reluctant to switch to OPS (22 per cent). That is, states that are in a financially worse condition want to burden their finances even more with OPS, while states that are slightly better off are more financially prudent by resisting OPS. Punjab has debt of a whopping 48 per cent of GDP and spends nearly one-fifth of its income on just pensions for government employees, who constitute a mere 6 per cent of the total families in the state. Similarly, Himachal’s debt levels are 42 per cent with a pension expenditure of 21 per cent for just one-fifth of the households. When these states spend so much of their income on just 20 per cent of the families, they will not have enough resources to cater to the basic needs of the remaining 80 per cent, which forces them to borrow more money.
With high existing debt, the states that are implementing OPS neither have the financial muscle nor the powers to raise their own finances and are dependent on the Centre to provide funds either through devolution of taxes collected from other states or by borrowing and lending. This is where it gets complicated. Just four large states – Maharashtra, Tamil Nadu, Karnataka and Gujarat — are net contributors to the Union government’s tax pool while most other states are net takers. For example, for every Rs 100 that an average Maharashtrian pays in all forms of taxes to the Union, nearly Rs 70 is sent to other states. But for every Rs 100 that the average Punjabi or Rajasthani pays to the Union government, they get back Rs 150. In a sense, when the Punjab or Himachal government claims it has the right to decide on OPS, it is actually paid for indirectly by the future generations of people in Maharashtra, Gujarat, Tamil Nadu and Karnataka through the Union government. (Switching to OPS may be financially beneficial in the short-term but harmful in the long-term.)
To be sure, such redistribution from richer states to needier ones is neither unique to India nor confined just to the OPS. The purpose of such redistribution is to close the gap between these states over time.
Unfortunately, the gap between the “net giving” and the “net taking” states has only increased. For example, the gap between the debt levels of states that have implemented OPS (Bengal, Rajasthan, Punjab, Jharkhand, Chhattisgarh, Himachal) vis-à-vis the states that have resisted OPS (Maharashtra, Tamil Nadu, Gujarat, Karnataka) has increased from 13 per cent in 2003 to 20 per cent of GDP in 2023. To put it simply, financially weaker states are only taking more from the Union government’s tax pool and not less.
This pattern of the richer states giving and the needier states taking more and more over time without closing the gap is unsustainable and dangerous. Profligate schemes like OPS that lavish money on the small creamy layer of government workers at the expense of the vast majority of their poor will only exacerbate the gap between the richer and poorer states.
At some point, the richer states will start to question the efficacy of such redistribution and the need for them to continue to fund regressive schemes in poorer states. Why should a financially more responsible state continue to deprive its own government workers of higher pensions and tax its future generations to provide for other states to squander on regressive schemes like OPS? This question is the fiscal elephant in the federalism room of the nation.
The decision on what to spend money on may be a state’s right but the money is a national issue.
Duly elected state governments must have the right to frame their own policies but they also need to be able to fund their programmes and be accountable. Until such time, India’s federalism is like the troubled teenager, squabbling for freedom with her parents and older siblings.