Enlightened leadership needed to resolve north-south tax dispute

This (north-south divide in deciding on the distribution of the tax pool among states) is a complex political challenge beyond the remit of the Finance Commission. Resolving it will demand enlightened leadership at central and state levels that can look beyond politics and build a consensus around an optimal way forward - Duvvuri Subbarao, former RBI Governor

Former RBI Governor Duvvuri Subbarao has opined that only enlightened leadership at Centre and state levels can resolve the complex north-south divide in deciding on the distribution of the tax pool among states, saying it is beyond the remit of the Finance Commission.

Subbarao, who held various positions including the finance secretary of Andhra Pradesh and Union finance secretary, and wrote extensively on issues in fiscal federalism in his new book titled 'Just A Mercenary?: Notes from My Life and Career' further said that horizontal sharing of the divisible pool of taxes has always been a contentious issue but will be even more so in this round.

"This (north-south divide in deciding on the distribution of the tax pool among states) is a complex political challenge beyond the remit of the Finance Commission. “Resolving it will demand enlightened leadership at central and state levels that can look beyond politics and build a consensus around an optimal way forward," he said.

He pointed out that for every rupee they contribute to the centre's taxes, richer states like Tamil Nadu and Maharashtra get back less than a rupee while poorer states like Bihar and Jharkhand receive more than a rupee. "Such cross subsidization of poorer states by richer ones is inevitable in a large and diverse country like ours and has, in fact, been an accepted principle," Subbarao said.

The 16th Finance Commission (16th FC) has been set up and the debate of economically and socially better-off southern and western states 'subsidising' the northern and eastern states has begun again "As you say, there is already an emerging north-south divide on the economy front. The question is, are we hitting the limits of such cross subsidization?," he asked.

According to Subbarao, many headline numbers suggest that the southern states are doing better in terms of infrastructure, private investment, social indicators and rule of law which has put them on a virtuous cycle of growth and prosperity and widened the north-south gap. "Given their urge to move up faster, how much more of cross subsidization will the southern states countenance? And for how much longer?," he wondered.

While noting that the looming delimitation that is due in 2026 based on updated population data, Subbarao said over the last few decades, population growth rates in the southern states have declined more sharply than in the north. "If as a consequence, the southern states lose their relative share of parliament seats, they will face the double whammy of reduced political clout combined with an open-ended commitment to cross subsidization," he said.

Subbarao was finance secretary (2007-08) before taking over as the governor of the RBI for five years on September 5, 2008, a few days before the breakout of the Lehman Brothers crisis. Lehman Brothers crashed into bankruptcy on September 16, making it the biggest corporate failure in history.

Asked to comment on criticism that he did not buy up dollars when there were huge inflows during 2010-11, and instead allowed the rupee to appreciate, Subbarao said that was a deliberate decision informed by several considerations.

"Holding reserves is not costless, especially as our reserves are built from borrowed resources," Subbarao said, adding, RBI intervention in the market shifts the burden of adjustment from one segment of the economy to another. He further explained that the stated policy of the Reserve Bank is to intervene in the market only to prevent volatility in the exchange rate.

"Juxtapose my alleged inaction against that policy. "As I saw it, there was no volatility in the exchange rate during 2010-11 to justify intervention. I felt obliged to walk the talk," he said. Subbarao noted that if the Reserve Bank were to step in every time the exchange rate moved, they would happily outsource their external management to the Reserve Bank. "That would be a costly moral hazard," he said.

Subbarao was at the helm of RBI during the taper tantrums in 2012-13 when the rupee crashed by 20 per cent peak to trough.

Referring to Prime Minister Narendra Modi's speech at the 90th anniversary celebrations of the RBI, Subbarao said, to make the rupee more internationally acceptable, the central bank should become less interventionist, besides fulfilling other conditions. Responding to a question on freebies, Subbarao said in a poor country where millions struggle to make a decent livelihood, transfer payments to the most vulnerable segments are necessary, indeed even mandatory. "But that has to be within limits especially as these freebies are financed by borrowing," he pointed out.

On the other hand, Subbarao said, competitive populism like what is unfolding -- political parties outdoing each other in wooing voters with freebies -- is fiscally perilous. "I believe all political parties are guilty of this and trying to apportion blame will be a wrong start," he said. Former RBI governor emphasised that there is a strong case for the central government that comes into office post elections to issue a white paper explaining to the larger public in plain language the costs and benefits of freebies.