Finance Commission to Look Into the Problem of Defence Funding

In July this year, The Government asked the Fifteenth Finance Commission under the chairmanship of former bureaucrat N K Singh to explore the possibility of allocating ‘adequate, secure and non-lapsable’ funds for defence and internal security and also to examine whether a separate mechanism could be created for the purpose

Indian Army

By Amit Cowshish

Taking note of the persistent underfunding of defence, the union cabinet decided to tread a new path in a bid to resolve the problem. In July this year, it asked the Fifteenth Finance Commission to explore the possibility of allocating ‘adequate, secure and non-lapsable’ funds for defence and internal security and also to examine whether a separate mechanism could be created for the purpose. The term of the commission has been extended till November 30, 20190 to enable it to look into these – and other – issues and submit its recommendations.

The Constitution of India envisages Finance Commissions to be set up both at the centre and in the states. The Fifteenth Finance Commission is the central commission set up by the President in pursuance of article 280 of the Constitution, which requires it to make recommendations as to:

(a) The distribution between the Union and the States of the net proceeds of taxes which are to be, or may be, divided between them and the allocation between the States of the respective shares of such proceeds;

(b) The principles which should govern the grants-in-aid of the revenues of the States out of the Consolidated Fund of India;

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(c) The measures needed to augment the Consolidated Fund of a State to supplement the resources of the Panchayats in the State on the basis of the recommendations made by the Finance Commission of the State;

(d) The measures needed to augment the Consolidated Fund of a State to supplement the resources of the Municipalities in the State on the basis of the recommendations made by the Finance Commission of the State;

(e) Any other matter referred to the commission by the President in the interests of sound finance

The requirement of funds for armed forces is substantial. In FY 2018-19 alone, the gap between the demand projected by them and the actual allocation was approximately Rs 1.12 lakh crore

Considering the constitutional remit of the finance commission, it is a bit surprising that the issue concerning inadequate funding of defence and internal security has been referred to it. It clearly does not fit into any of the first four clauses mentioned above. At best, it can be argued that the reference has been made under the last clause of Article 280, assuming that resolving the issue of underfunding is in the ‘interest of sound finance’. Be that as it may, considering that the root cause of the problem is already known and the options for resolving it are rather limited, it would be interesting to see what solution the Fifteenth Finance Commission come up with.

The root cause of the problem is very clear. In one word, it is about inadequacy of financial resources of the union government. It is undeniable that every year the funds allocated for defence are much lower than the demand projected by the armed forces. (In all probability, this will also true of the internal security.) But, contrary to the perception that many have, this mismatch is not on account of lower priority accorded to defence and internal security by successive governments, political indifference or bureaucratic machinations. The simple truth is that the government is unable to generate adequate revenue to be able to meet the demand of the armed forces in full, as indeed of other sectors like agriculture, health, education, infrastructure and internal security.

The requirement of funds for the armed forces is substantial. In FY 2018-19 alone, the gap between the demand projected by them and the actual allocation was approximately Rs 1.12 lakh crore, not to speak of the shortfall in the allocation made to other organisations such as the Defence Research and Development Organisation (DRDO), Border Roads and the Coast Guard. Even if the Fifteenth Finance Commission is not required to look into the requirement of these organisations (notwithstanding the fact that at least Coast Guard also plays an important role in country’s security), it would still need to club the requirement of internal security organisations with that of defence to determine the overall magnitude of the requirement and recommend suitable measures for resolving the problem. By any stretch of imagination, the magnitude of the problem would be enormous.

A more viable measure to raise revenues specifically for defence and internal security would be to levy a cess on income/corporate tax. Even this may not go down well with the Indian taxpayers, but it would not be a substantial burden on them

At this stage, the choices before the commission appear to be broadly limited to four measures. The first option would be to recommend lowering of the share of the states in the tax revenue of the union, which was raised to 42 per cent on the recommendation of the Fourteenth Finance Commission. But, for obvious reasons, it would be naïve to expect such a recommendation to be made or, if made, to be accepted by the states.

The second option would be to recommend measures to increase revenues of the union so that more funds could be allocated for defence and internal security or to generate revenue specifically for this purpose. Generally speaking, this can be done through taxation, borrowing or disinvestment. The option of raising revenues through taxation seems unworkable as there are severe limitations on raising the tax rates or expanding the tax base. At any rate, as any increase in the tax revenues would flow into the divisible pool of funds, it would not only get divided between the Centre and the states but also be susceptible to pressure from other sectors crying out for higher allocations.

As for borrowing, the country has been struggling to meet the fiscal and revenue deficit targets mandated by the Fiscal Responsibility and Budget Management Act, 2003. Therefore, borrowing – and it will have to be on a recurring basis as the problem is not limited to meeting a one-time requirement of defence and internal security -is not a viable option, especially since it inevitably increases the government’s liability for payment of interest, requiring it to dip deeper into the revenue receipts. As for disinvestment, it cannot also be a recurring source of funding for defence and internal security.

The third option would be to recommend raising of revenues specifically for defence and internal security. This can be done by floating defence bonds and/or levying a defence cess on income/corporate tax. Since floating of bonds would also add to the liability of the government (on account of payment of interest and redemption), the commission may not consider it advisable to recommend this measure.

A more viable measure to raise revenues specifically for defence and internal security would be to levy a cess on income/corporate tax. Even this may not go down well with the Indian taxpayers, but it would not be a substantial burden on them and, therefore, it may be more acceptable than a general increase in the tax rates. The revenues generated through cess may not be divisible between the Centre and the states and could be used specifically for the purpose for which the cess is levied.

The finance commission would have to depend on inputs mainly from the ministries of defence and home affairs to assess and recommend the quantum of cess. These inputs may not be accurate or realistic. Costing is not a strong point with either of these two ministries and, considering the objective of the task assigned to the finance commission, the defence and internal security apparatus may be tempted to project inflated requirement in the hope that the finance commission would try to meet their expectations in a substantial measure. The commission clearly has its work cut out for itself.

The finance commission would need to recommend a moderate rate of cess, striking a balance between the ability and willingness of the taxpayers to pay the cess – in addition to the health and education cess already being paid – and the imperatives of meeting the requirement of defence and internal security to a substantial extent, if not fully. Since it is not going to be easy to determine an optimum rate of cess, the possibility of this decision being left by the finance commission to the union government cannot also be ruled out.

The fourth option would be to recommend monetisation of the idle assets like land and non-moving inventory/stores held by the defence ministry in general and the armed forces in particular. Some possibility also exists for generating revenues through commercial exploitation of civil infrastructure and certain facilities held by the armed forces. The revenue generated through such monetisation and commercial exploitation could be used for meeting the capital and revenue expenditure of the armed forces.

Regardless of which option, or combination of options, is recommended by the Fifteenth Finance Commission, it must be supplemented by the suggestion to explore the possibility of containing defence expenditure. A committee set up by the Ministry of Defence in 2008 to review defence expenditure had pointed out that there is considerable potential for containing the expenditure and suggested that the areas in which it could be contained must be identified by the armed forces on their own volition. Nothing came out of it, though. The need for carrying out this exercise is as relevant today as it was more than a decade ago.

Irrespective of what finance commission recommends, the impact of those recommen-dations on the problem of underfunding of defence and internal security would depend on logicality and viability of the recommen-dations and their acceptance by the government

Bringing about jointness in training, logistics, stocking, maintenance, infrastructure, and transportation as a means of introducing economy in expenditure have been talked about for a long time, apart from saving in manpower cost by increasing the colour service, creating integrated commands, redeployment from non-combat post to combat posts, and outsourcing. The finance commission could consider reiterating the need to explore these possibilities in a time-bound manner.

It is interesting that apart from being tasked with the responsibility of addressing the concerns regarding inadequacy of budget outlay, the fifteenth Finance Commission has also been asked to examine whether a separate mechanism for funding of defence and internal security, which will not entail lapse of funds, ought to be set up and, if so, how such a mechanism could be operationalized.One obvious question is why such a mechanism is called for specifically for defence and internals security and not for other sectors like agriculture and infrastructure. But even if this question is set aside, there does not seem to be any strong case for creating such a mechanism. At any rate, it may not be easy to work out the modality of operationalising such a mechanism.

In the face of persistent budgetary deficits, it makes little sense to transfer the money into some non-lapsable fund and keep it idle. If, on the other hand, it is to be a notional fund, it will be of little help as any appropriation from this notional fund will need to be authorised by Parliament and the money so authorised will need to be raised by the finance ministry as a part of the normal budgetary process in the year in which the money is to be appropriated out of the so-called non-lapsable fund.

All said and done, irrespective of what the finance commission recommends, the impact of those recommendations on the problem of underfunding of defence and internal security, would depend on logicality and viability of the recommendations and their acceptance by the government, which will be susceptible to political considerations, fiscal realities and the imperatives of cooperative federalism.

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