New defence fund may reduce divisible central tax pool : 26-07-2019

The Fifteenth Finance Commission (15th FC) headed by NK Singh is expected to create a defence and internal security fund likely to be called Rashtriya Suraksha Nidhi (RSN) by setting aside money from gross tax revenues of the central government. The Union cabinet cleared enabling approvals on July 17, increasing focus on national security while also indicating it wants states to share the financial burden of maintaining and upgrading its security apparatus, including buying weapons from global suppliers, ET’s conversations with highly placed sources and review of confidential documents reveal. 

Although the original Terms of Reference (ToR) of the 15th FC did ask it to look into the demand on central resources for defence and national security, it had not specifically mandated it to suggest creation of a fund outside the Consolidated Fund of India. The cabinet decision to amend the ToR came after prolonged discussions between the government and the FC and splitting hairs over the commission’s mandate and legal powers failed to clear a way for creating an exclusive corpus. 

A top official of the 15th FC had told ET before the Cabinet approval came that the commission did not have the mandate to create the fund. “We can only recommend a formula for sharing central tax revenues between the union and the states. The centre can decide whatever it wants to do with its share. Our job is to find a balance,” he had told ET on condition of anonymity. 

In reply to ET’s queries after the July 17 cabinet decision, a commission spokesperson said: “In view of the fact that the commission is yet to receive revised TOR from the President of India, it is not able to respond at this moment of time.’ 

After year-long deliberations, the 15th FC came up with four options. One was to allocate funds to the centre through a cess or a surcharge. However, it would have been steep as defence and security expenditure requirement is high. Also, the 10th Finance Commission had laid down the principle that cess and surcharge should be temporary and rare. 

The second option was to increase the weightage of defence and national security while working out the devolution formula. That would have likely shrunk the states’ share from the 14th FC’s award of 42%. The third way was to earmark a portion of the centre’s share for defence which would have helped create a fund but made no difference to the money available to the central government. 

The last and preferred option was to sequester a portion of the gross tax revenues itself for defence and internal security by creating a Rashtriya Suraksha Nidhi before computing the divisible pool. That means the total money available for sharing itself would be less. It was a controversial option but the most viable one. The FC then sought expert opinion from senior lawyer K Parasharan. 

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The legal expert said in the context of cooperative federalism, any allocation for defence and internal security under Article 280 (the FC’s Constitutional foundation) “may result in criticism by the states that their share of allocation has been reduced from the previous years”. 

He went on to say that the share of the states from the divisible pool was not a benefaction of the Union or Finance Commission. “It is an entitlement of states whose contours are to be determined fairly by the FC on the basis of a clear and rational formula.” 

The way out, Parasharan offered, was the commission could be empowered if the President made a supplementary reference enabling the 15th FC to consider how defence and internal security should be funded while devising its vertical devolution formula. The legal opinion which ET has reviewed clearly said without the amendment, the 15th FC could only make a suggestion and the government would have to go to Parliament to introduce a defence-specific levy. 

Discussions between the defence ministry and the FC began in early 2018 after the finance ministry rejected the demand for a non-lapsable fund in December 2017. “I am in fact even talking to the (15th) Finance Commission’s new chairman NK Singh to make sure that defence procurement funding, especially capital expenditure …is a non-lapsable kind of allocation,” the then defence minister and now finance minister Nirmala Sitharaman had said at a Confederation of Indian Industry event. 

In a presentation to the FC, the defence ministry had argued that defence and national security should be included “in our understanding of sustainable development’’. To bolster its argument, the government pointed to the United Nations declaration on Transforming our world: The 2030 agenda for sustainable development which stated, “there can be no sustainable development without peace and no peace without sustainable development”, documents reviewed by ET show. 

It said issues like terrorism, insurgency and securing national borders should be recognised as a shared responsibility of the union and the states without which the national development framework will remain incomplete. 

The government based its demand on a report of Parliament’s Standing Committee on Defence headed by BC Khanduri that had recommended creation of a non-lapsable, roll-on fund for defence purchases. Although the defence ministry was in favour of it, the finance ministry had rejected it saying balances in non-lapsable fund anyway will not be automatically available to the ministry without Parliament approval. It said non-lapsable funds were often idly parked instead of being used to pay off urgent  urgent bills. 

“Moving general revenues out of the CFI (Consolidated Fund of India) and parking in corpus fund is against the spirit of Article 266(1) [which governs the CFI] of the Constitution,’’ the finance ministry argued. It feared that allowing one could raise competing demand from other ministries. The government then approached the 15th FC. 

It told the commission that defence purchases took time and prolonged negotiations, and often funds lapsed because they were not utilised in the year they were allocated. The standing committee had noted that the finance ministry always reduced by mid-year what it promised in the annual budget saying expense trends showed the ministry was not spending as much as budgeted. “Though there has been underutilization of capital budget with reference to Budget Estimates (except in 2016-17), there has been either excess expenditure or more than 99.9% utilization when compared to Final Grant,’’ the committee noted. 

It also pointed out that underutilization of funds compared to budget estimates allocated showed inefficient budgetary planning by the defence ministry. 

The defence ministry wanted India’s defence expenditure to be benchmarked to countries in the North Atlantic Treaty Organisation (NATO) which are expected to spend at least 2 per cent of their GDP on defence. Incidentally, the US has criticised NATO allies for not keeping up their spending to the promised 2% even as the US Senate passed a bill elevating India to a status equivalent to them for defence deals. The Modi government has gradually been increasing purchases from the US with which it is also engaged in a confrontation over trade imbalances. 

Indian ambassador to the US Harsh Shringla has indicated that India would buy more weapons from the US. “There has been a tradition of dependence on defense equipment from Russia,” Shringla was reported as saying in for defence and national security, it had not specifically mandated it to suggest creation of a fund outside the Consolidated Fund of India. The cabinet decision to amend the ToR came after prolonged discussions between the government and the FC and splitting hairs over the commission’s mandate and legal powers failed to clear a way for creating an exclusive corpus. 

A top official of the 15th FC had told ET before the Cabinet approval came that the commission did not have the mandate to create the fund. “We can only recommend a formula for sharing central tax revenues between the union and the states. The centre can decide whatever it wants to do with its share. Our job is to find a balance,” he had told ET on condition of anonymity. 

In reply to ET’s queries after the July 17 cabinet decision, a commission spokesperson said: “In view of the fact that the commission is yet to receive revised TOR from the President of India, it is not able to respond at this moment of time.’’ 

After year-long deliberations, the 15th FC came up with four options. One was to allocate funds to the centre through a cess or a surcharge. However, it would have been steep as defence and security expenditure requirement is high. Also, the 10th Finance Commission had laid down the principle that cess and surcharge should be temporary and rare. 

The second option was to increase the weightage of defence and national security while working out the devolution formula. That would have likely shrunk the states’ share from the 14th FC’s award of 42%. The third way was to earmark a portion of the centre’s share for defence which would have helped create a fund but made no difference to the money available to the central government 

The last and preferred option was to sequester a portion of the gross tax revenues itself for defence and internal security by creating a Rashtriya Suraksha Nidhi before computing the divisible pool. That means the total money available for sharing itself would be less. It was a controversial option but the most viable one. The FC then sought expert opinion from senior lawyer K Parasharan. 

The legal expert said in the context of cooperative federalism, any allocation for defence and internal security under Article 280 (the FC’s Constitutional foundation) “may result in criticism by the states that their share of allocation has been reduced from the previous years”. 

He went on to say that the share of the states from the divisible pool was not a benefaction of the Union or Finance Commission. “It is an entitlement of states whose contours are to be determined fairly by the FC on the basis of a clear and rational formula.” 

The way out, Parasharan offered, was the commission could be empowered if the President made a supplementary reference enabling the 15th FC to consider how defence and internal security should be funded while devising its vertical devolution formula. The legal opinion which ET has reviewed clearly said without the amendment, the 15th FC could only make a suggestion and the government would have to go to Parliament to introduce a defence-specific levy. 

Discussions between the defence ministry and the FC began in early 2018 after the finance ministry rejected the demand for a non-lapsable fund in December 2017. “I am in fact even talking to the (15th) Finance Commission’s new chairman NK Singh to make sure that defence procurement funding, especially capital expenditure …is a non-lapsable kind of allocation,” the then defence minister and now finance minister Nirmala Sitharaman had said at a Confederation of Indian Industry event. 

In a presentation to the FC, the defence ministry had argued that defence and national security should be included “in our understanding of sustainable development’’. To bolster its argument, the government pointed to the United Nations declaration on Transforming our world: The 2030 agenda for sustainable development which stated, “there can be no sustainable development without peace and no peace without sustainable development”, documents reviewed by ET show. 

It said issues like terrorism, insurgency and securing national borders should be recognised as a shared responsibility of the union and the states without which the national development framework will remain incomplete. 

The government based its demand on a report of Parliament’s Standing Committee on Defence headed by BC Khanduri that had recommended creation of a non-lapsable, roll-on fund for defence purchases. Although the defence ministry was in favour of it, the finance ministry had rejected it saying balances in non-lapsable fund anyway will not be automatically available to the ministry without Parliament approval. It said non-lapsable funds were often idly parked instead of being used to pay off urgent  bills. 

Moving general revenues out of the CFI (Consolidated Fund of India) and parking in corpus fund is against the spirit of Article 266(1) [which governs the CFI] of the Constitution,’’ the finance ministry argued. It feared that allowing one could raise competing demand from other ministries. The government then approached the 15th FC. 

It told the commission that defence purchases took time and prolonged negotiations, and often funds lapsed because they were not utilised in the year they were allocated. The standing committee had noted that the finance ministry always reduced by mid-year what it promised in the annual budget saying expense trends showed the ministry was not spending as much as budgeted. “Though there has been underutilization of capital budget with reference to Budget Estimates (except in 2016-17), there has been either excess expenditure or more than 99.9% utilization when compared to Final Grant,’’ the committee noted. 

It also pointed out that underutilization of funds compared to budget estimates allocated showed inefficient budgetary planning by the defence ministry. 

The defence ministry wanted India’s defence expenditure to be benchmarked to countries in the North Atlantic Treaty Organisation (NATO) which are expected to spend at least 2 per cent of their GDP on defence. Incidentally, the US has criticised NATO allies for not keeping up their spending to the promised 2% even as the US Senate passed a bill elevating India to a status equivalent to them for defence deals. The Modi government has gradually been increasing purchases from the US with which it is  also engaged in a confrontation over trade imbalances. 

Indian ambassador to the US Harsh Shringla has indicated that India would buy more weapons from the US. “There has been a tradition of dependence on defense equipment from Russia,” Shringla was reported as saying in Washington in May. 

“But if you go by SIPRI (Stockholm International Peace Research Institute) figures, in the block year 2008 to 2013 we imported 76% of our defense items from Russia. In the next five-year block, from 2013 to 2018, this came down 58% and in the same period our imports from the United States increased by 569%,” he was quoted as saying. “So that itself tells you that, when we have a choice … we are obviously diversifying our purchases.” 

India’s defence budget for 2019-20 is at Rs 3.05 lakh crore is 1.45% of GDP of which a little over a third is capital expenditure. 

Source : Mint