Demonetization – Building Allies vs Forcing into Action

Ever since the demonetization decision was made public by the Union Government of India, on the 8th of November 2016, lot has been discussed about the pros and cons of the measure. However, not much has been discussed about the measure from the federalism angle. In this article, we try to look at the whole demonetization exercise from the federalism point of view.

Taxation Powers in a Federal Polity
In many mature democracies, the taxation powers are distributed between the states and the union (also called as ‘federal’) governments. Not just the indirect taxes, even the direct taxes like Income tax and Corporate tax powers are with the state governments too. In federal polities like USA, Canada or Australia, this is the norm.

In India however, the powers to levy direct taxes rest solely with the Union Government. This in itself is, over-centralization of powers. When nations like Canada and Australia with population of 20-30 million take fiscal federalism seriously, what stops the highly diverse nation with a population of 1.25 billion from taking fiscal federalism seriously?

The Black Money
In the previous paragraphs, we discussed about direct taxation powers. Because by definition, black money is the amount for which direct tax has not been paid. By retaining the power to levy direct taxes, the union government has kept to itself all the incentives to fight tax evasion. Had the state governments been provided with direct taxation powers, as is the case in mature democracies, the union would have found natural allies in all the state governments in the fight against tax evasion.

Building Allies vs Forcing into Action
The current approach, taken by the Union Government to catch tax evaders, is more like ‘Forcing’ the state governments into action. Quite naturally, when something is forced upon someone, the reluctance levels will be high and enthusiasm levels will be low. Needless to add, that in a federal setup, such moves are against the fundamental principles of federalism. The frequently heard term of “co-operative federalism” appears to be lacking any substance, considering the current approach.

For co-operation between any two elected governments, there must be an incentive at play. Had the direct taxation powers been in concurrent list, the resulting bounty from the fight against tax evasion would have been an incentive, for both the union and the state governments. To tackle tax evasion, whether it is the USA working with Switzerland, or Germany working with Panama, the approach one can see is that of ‘carrot & stick’. That is how co-operation is achieved, and is made effective. “Stick alone” approach, doesn’t build a strong and effective co-operation.

The demonetization exercise by the union government is akin to “stick-only” approach, and is evident that there was no effort to build consensus among the state governments and the union. This one exercise has strained the federalism-fabric so much, that we might start hearing the benefits of common currency across the union of India being questioned.

GST: What it Means to Federalism in the Indian Union

The Goods and Services Tax is being sold as the best thing that could happen to the system of indirect taxes in the history of the Indian Union. Simplification and streamlining of taxes, uniform taxation across the union, one integrated market, multitude of opportunities to leverage economies of scale, boost to the GDP and significance to the Make in India initiative - the benefits, we are told, are astounding. But what does it mean to the states and their diverse peoples?

A brief history of GST in the Indian Union
 
To begin with, let us look at the history of GST. The proposal was first made in the Union Budget speech of 2006-07. None of the states had asked for it in the first place. The Union Government, nevertheless, wanted to roll out a national-level GST. Meaning, indirect taxes like excise duty, additional excise duty, service tax etc., that fall under the purview of the Union Government, and sales tax, purchase tax, entry tax, entertainment tax etc., that come under the state governments would be subsumed under one national-level tax structure, and that would have no state component. So, the States would get no revenue from goods and services; instead the Union would own and collect all taxes and redistribute among the States.

It was then handed off to the Empowered Committee of Finance Ministers to lay the road-map for its implementation across the Union. Since there was representation of the states in the committee, the idea of national-level GST was opposed. Which state would want to lose its revenues or even the control over its revenues? Finally, a compromise was reached with the dual-GST model, which included a state component too. But as we will see further, the compromise does not necessarily restore control back to the states.

GST - Thrust upon unwilling states

The idea of GST - whether a national level GST, as it was to start with, or a dual GST, as it is being proposed as a compromise now - has come top down from the Union to the States. The States have only agreed to it as a compromise and never wanted such a structure in place. When the States did not want what gave the Union the legitimacy to impose a new taxation structure on them? Note that by legitimacy I do not mean Constitutional legitimacy; I am rather questioning the invasive and imperious attitude of the Union Government in a federal setup comprising several diverse states, each with its unique history, culture, issues and state of socio-economic development.

The AIADMK rightly pointed out the effect the GST Bill will have on the autonomy of the states. In a dissent note the party observed:

..the GST Council, as a constitutional body, impinged on the legislative sovereignty of both Parliament and the State legislature and would jeopardise the autonomy of the States in fiscal matters.

The GST Council will be setup with the passage of the Goods and Services Tax Bill. It will be headed by the Union Finance Minister with the state Finance Ministers as its members. This council will be responsible for the categorization of goods and services, and will decide the tax rates on the same. In matters pertaining to taxes and revenues, all States in the Union should abide by its orders and decisions. What democratic legitimacy and credibility will an elected body retain, when its own matters are decided by a superseding external council that is nominated? The concerns of sovereignty and autonomy of the States, expressed by the AIADMK are absolutely relevant.

No doubt, there is representation of the states in the council. The council, as already stated, will have state Finance Ministers as members. But the weightage given to the states is something to be noted. The Union Government has decided to hold a weightage of one-third of the total votes for itself, and has given two-thirds' weightage to all the states put together. With this, the Union has ensured it has veto power of sorts for itself in the council. The States, needless to say will be dummies. Barring a few exceptional cases in which a majority of States may come to a common agreement, this setup ensures the Union has total control in all matters of indirect taxation in the country.

The GST Council is anti-Federal
 
States that are ruled by the so called 'national' parties, usually have to toe the line of their party high-command, whose agenda is primarily focused on holding the reins of power at Delhi. The interest of the people of the State comes next to this agenda. While this will tilt the balance of power more in favour of the Union Government, those States with less influence in the Union and those ruled by state-level parties will find it much harder to influence any decisions in their favour.

It is also being said that the States can appeal to the council. But a democratically elected government going to a council for matters such as its own taxes and revenues is fundamentally opposed to the idea of democracy and federalism. A legislature elected by the people should hold these powers, not a council or a committee. It also becomes much tougher for the states to come up with and roll out any new or innovative economic policies. They all will have to operate within the limits imposed by this one framework decided by the council.

Who will really benefit from economies of scale?

I also want to address the argument of integrated market and economies of scale. Who does this benefit? It certainly benefits businesses and enterprises that are well established and have large scale inter-state operations. But what if the states want to take a different approach to nurture local entrepreneurship, for example? What autonomy will they be left with to roll-out an economic policy favouring local entrepreneurship when a uniform framework is already decided by and rolled out from a committee sitting in a far-off Delhi?

 Do we really need an integrated market? Do we really need economies of scale? Can our people leverage the so-called economies of scale effectively? These are questions that each state and its people should discuss, debate and take decisions on. Rolling out from Delhi, a single policy for diverse peoples, makes little sense. In fact, it comes with the attitude of 'I know what you need better than you do' - violating the fundamentals of free choice, liberty and democracy.

By this I do not want to sound like a conservative opposed to economic progress. In fact, in today's world, free and democratic countries have attained much stable and viable economic progress in comparison to autocratic, dictatorial or less democratic ones. The USA, termed as the epitome of free- market economy does not have a unified, integrated market. The sales taxes vary across states. In states like Alabama, Oregon, New Hampshire etc., there is no sales tax at all. In contrast, California has the highest rate of sales tax. These rates are decided by the States themselves, the Federal Government has little say in it. To add to it, the cities, the counties and other local bodies may levy additional taxes.  It is not just sales taxes, the States have their share of income tax as well, which is totally a Union subject in India. The USA has shown that a free market does not necessarily have to compromise on liberty of its people or the autonomy of its states.

Another argument in favour of GST is the ease of doing business in India, as businesses do not have to deal with different tax structures in different states. This argument too does not hold any water, when you look at countries like the United States. Despite different laws and taxation structure across different states, USA is way ahead of the Indian Union in this parameter.

Lot is being said about federalism, particularly co-operative federalism, of late. But the GST in its current form will be disastrous to the autonomy of states and the overall federal setup of the Indian Union. Here is a video recording of a talk on the same subject that I gave at Total Kannada, Jayanagar, Bengaluru, on the 13th of March. In this talk, which is in Kannada, I make the same arguments of democracy, federalism and liberty in purview of the GST bill. Comments / feedback/ discussion welcome.

Governors' Post in the States of India, a Colonial Legacy

Warren Hastings, the first Governor General of Bengal.
Pic source: www.artgallery.nsw.gov.au

Ever since the BJP led NDA government took control at Delhi last year, there were words doing rounds that UPA appointed governors will be asked to go. As things evolved, a few of the governors voluntarily stepped down while a few others locked horns with the union government over their transfers. Looking at these events one can’t resist thinking whether such an anti-federal post as the Governor is really necessary.

History of the post of Governor
A Governor’s post has a colonial history. British used a post called resident to boss over the princely states as well as the presidencies of India. The resident post was not unique to India, but was present across geographies ruled by British (as well as other European colonialists). This wiki excerpt elaborates on the role of residents and how they were chosen in the yesteryears:

Some official representatives of European colonial powers, while in theory diplomats, in practice exercised a degree of indirect rule. Some such Residents were former military officers, rather than career diplomats, who resided in smaller self-governing protectorates and tributary states and acted as political advisors to the rulers. A trusted Resident could even become the de facto prime minister to a native ruler. In other respects they acted as an ambassador of their own government, but at a lower level, since even large and rich native states were usually seen as inferior to Western nations. Instead of being a representative to a single ruler, a Resident could be posted to more than one native state, or to a grouping of states which the European power decided for its convenience. This could create an artificial geographical unit, as in Residency X in some parts of the British Indian Empire.

Power held by the Governors in the Indian Union

Pic source: wikipedia.org

Let us have a look at the recent Governor appointees to the state of Karnataka – Mr. Hansraj Bharadwaj, a former congress party member, appointed during the UPA regime; Mr. Vajubhai Vala, a former member of the BJP, appointed as the governor within 100 days of the NDA government taking over at Delhi. Looking at this pattern, it becomes clear that the methods of choosing governors hasn’t changed much since the British time. Originally claimed to be a post that ensures continuance of government at State level, this institution of governor defined in our constitution appears to be mostly used by central governments to meet their political ends.

The political leverage aside, the Constitution of India has given certain arbitrary powers to governor, though a governor is not directly elected by the people of the respective State. Article 163(2) from the Constitution :

If any question arises whether any matter is or is not a matter as respects which the Governor is by or under this Constitution required to act in his discretion, the decision of the Governor in his discretion shall be final, and the validity of anything done by the Governor shall not be called in question on the ground that he ought or ought not to have acted in his discretion.

The key takeaway from this article is, a Governor’s action shall not be questioned. This exposes a fundamental flaw, for there must be no person in a democracy who is immune to judicial scrutiny.

In Karnataka as well as other states of India, no matter who the people vote to power, the top most decision making powers reside with the one loyal to the establishment at Delhi. Positions occupied by appointment having greater powers than the elected representatives is something that doesn't gel well with the democracy.

The Governors, sometimes so disconnected from ground level realities, tend to look at all States uniformly. This approach stands out especially in linguistic matters, given the linguistic grounds for State formation in India. Within days of his appointment as governor of the state of Karnataka, Mr. Vajubhai Vala made a statement that he could manage his work in Karnataka through Hindi. This statement of his is a display of his disconnect from the people of Karnataka.

(This piece had originally appeared in thefederalist.in)

Devolution to States Should Be Bharatiya Approach to Development

 "Perhaps most importantly, the institution must adhere to the tenet that while incorporating positive influences from the world, no single model can be transplanted  from outside into the Indian scenario. We need to find our own strategy for growth.  The new institution has to zero in on what will work in and for India.   It will be a Bharatiya approach to development".

The above is an excerpt from the press note of NITI Aayog, the institution that replaces the Planning Commission. It is true that successful approaches to development and progressive economic policies cannot be replicated across the globe. A model that works for one county may not fit another. The social challenges, the economic challenges and priorities are vastly different. Policies should also consider various sociocultural traits, and should be designed such that they not only help achieve development in the given cultural setting but also minimize any conflicts between development models and the cultural complexion.

Given this, it is obvious that India is different in itself and development models and policies that work in, let us say, Italy, or Germany, surely cannot be replicated here. Countries can learn from the accumulated experience of others and frame models and policies that suit their own characteristics. But will a county-wide policy work for India?

India has always tried to hold power at its Centre and has devolved very less to the states. The number of subjects that the states have jurisdiction over have been going down and the number that have moved to the Concurrent and the Union lists have increased. Whether it is finance and banking, railways, insurance, or aviation, policies are defined by the Union. This, needless to say, has resulted in approaches, often misaligned with local needs and priorities. It is being said that the NITI Aayog is setup with the objective of involving states in economic-policy making, in the name of ‘Co-operative Federalism’, but unless the states have enough autonomy to plan and device their own policies and schemes, the result will be the delivery of progress (from the Union) lacking any synchronization with local development needs.

Just the way Italy and Germany are different, Kerala and Haryana, for example, are quite different. Beti Bachao Abhiyan may be very relevant to Haryana, while it makes very little sense to Kerala. The Chief Minister of Kerala, Oommen Chandy, remarked that both Beti Bachao Abhiyan and Jan Dhan Yojana are irrelevant to Kerala as the state had already achieved high standards in the areas that these two schemes are devised to address.

Kerala, historically, has had a healthy sex ratio. In fact, its sex ratio went up from 1058 females to 1000 males in 2001 to 1084 females to 1000 males in 2011. Though Haryana bettered from 861 in 2001 to 877 in 2011 the state’s numbers are definitely worrying. The state Government of Haryana would be best placed to understand the true nature and the intensity of the issue, and address it accordingly. The design of the program, the kind of campaigns required to popularize and implement it, the challenges and hurdles, and the required funds are all better known to the state than to the Union. So, it is far better to leave the design and implementation of such programs to the states than have the Union roll out projects of such scale uniformly across the country that are often irrelevant to many regions and states.

Hence, in different aspects of development like education, health care and other human development indices, infrastructure, industries and entrepreneurship, agriculture, sociocultural issues and various other parameters, each state is unique in itself. A top-down approach to policy-making can be regressive, and may often work against the objectives of organized development. There can be no single ‘Bharatiya’ approach to development much like there can be no one model for the whole world. The Union should play the role of a facilitator to the states, rather than getting further into the centralizing business in an already centralized scheme of things if India should aspire for a healthy, sustainable, and all-round development.




(Image source: thehindubusinessline)