Why is it in the News?

As the union government constituted the 16th Finance Commission (FC), experts recommend including variables related to climate change, beyond forest cover.

Background:

• In the contemporary era, India has gained prominence as a key participant in global initiatives aimed at addressing climate change and promoting increased forest coverage.
• This engagement has not only positively impacted environmental sustainability but has also strengthened the adaptability of communities and ecosystems.
• In addressing the hurdles presented by climate change, the concept of fiscal federalism, with a specific focus on the role of the Finance Commission (FC), has emerged as a crucial factor in encouraging states to prioritize conservation endeavours.

Role of the Finance Commission in Fiscal Federalism and Forest Conservation:

• Promoting Conservation Initiatives: The Finance Commission's role has been pivotal in actively promoting and incentivizing state-led efforts towards forest conservation.
• Through dedicated fund allocations, the Commission acknowledges the inherent connection between vibrant forests, sustainable ecosystems, and the overall national well-being.
• Financial backing serves as a catalyst, motivating states to prioritize conservation endeavours while safeguarding their economic interests.
• Balancing Revenue Capacities and Expenditure Needs: Beyond their biodiversity significance, forest resources represent valuable economic assets for states.
• The Finance Commission recognizes that preserving existing forests and augmenting forest cover density directly impact the revenue capacities and expenditure requirements of states.
• Finding an equilibrium between economically exploiting forest resources and ensuring their conservation becomes essential for achieving both environmental sustainability and economic prosperity.

Previous Instances of Finance Commission Initiatives in Forest Conservation:

• The Finance Commission’s formulae for tax sharing have evolved since the first one, constituted in 1951, for the period 1952-1957.
  • Since then, FCs have been constituted at intervals every five years with the 16th one currently being implemented.
• Initially, the formula for distributing tax among states respectively, known as horizontal devolution, gave significant weightage, around 80% to 90%, to the population of the states, meaning states with higher populations were given a higher share of the tax.
  • Then, the 7th FC drastically reduced the weightage assigned to the population to 25% and increased the weightage given to equity, in which income, land area, and sometimes infrastructure and fiscal discipline too, played a significant role in determining how much each state would receive from the central government.
• Similarly, there have been changes in determining the funds allocation for environmental initiatives.
  • The 12th FC (2005-10) dedicated Rs 1,000 crore for forest conservation across states.
  • The 13th FC (2010-15) enhanced this allocation to Rs 5,000 crore.
    • However, it is important to note that these grants comprised less than 0.05% of the total funds transferred from the central government to the states.
• Ecological Fiscal Transfers (EFT) – where public revenue is shared based on ecological indicators – were introduced in 2015 with the 14th FC which incorporated forest cover as a criterion for tax devolution, allocating it a weightage of 7.5% in the distribution formula for the tax-transfer during the period 2015-16 to 2019-2020.
  • The 14th FC (2015 to 2020) considered several recommendations and replaced the grants with a more prominent placement for the forestry sector — it dedicated 7.5 per cent of the divisible central tax pool to ecology and forests.
    • The allocation was based on the forest cover in each state.
• The 15th FC (2021–22 to 2025–26) extended this share to 10 per cent.
• Having mobilised and distributed over Rs 4.5 lakh crore to states against not only their forest cover but also forest density, the 15th FC effectively became the largest payment for ecosystem services (PES) systems in the world.
  • The Commission also gave grants to combat air pollution.
• The fiscal transfers that are earmarked for a specific department or programme have traditionally been much smaller than fiscal transfers to the general state budget.
  • For example, the specific-purpose grants for forestry under the 12th and 13th FC were a fraction of the general-purpose transfers (those not assigned to specific purposes) that followed under the 14th and 15th FC.
• The formula-based finance commission transfers are unconditional and are not tied to the Department of Forest or Ecology.
• Whether there is a need for conditions to ensure the funds are invested in the environment, at least in principle, the enticement of receiving larger general-purpose transfers should motivate states to invest in forest protection.
• Since 2005, the central government has been sharing annual forest grants with states.
  • These grants serve as both compensation and incentive mechanisms.
  • However, it remains unclear to what extent these grants have contributed to the increased forest cover in the states.

Addressing Complexities in the Intersection of Fiscal Federalism and Environmental Conservation:

• Harmonizing Conservation Costs and Economic Imperatives: Balancing conservation expenses with economic necessities becomes challenging, particularly for states grappling with financial constraints.
  • The substantial opportunity costs linked with forest preservation may strain state budgets, presenting a hurdle in garnering widespread commitment.
• Innovating Financing Models for Conservation: Traditional financing models for conservation may prove inadequate or unsustainable in the long term.
  • Overreliance on grants can create dependencies, hindering the development of self-sustaining mechanisms for conservation.
• Addressing Climate-Induced Economic Vulnerabilities: The repercussions of climate change pose considerable threats to economic stability, especially for states heavily dependent on climate-sensitive sectors.
  • Unpredictable weather patterns, floods, and forest fires can intensify existing vulnerabilities.
• Strategically Allocating Resources: The Finance Commission encounters the intricate task of strategically allocating resources to maximize both environmental and economic advantages.
  • Ensuring targeted funding for critical conservation initiatives while aligning with state development objectives demands a nuanced approach.
• Integrating Environmental Goals with Fiscal Capacity: States may grapple with aligning their environmental objectives with fiscal capabilities, potentially creating a gap between aspirations and implementation.
• Ensuring Equitable Participation: A potential risk exists where states with greater fiscal capacities may disproportionately benefit from conservation incentives, potentially exacerbating existing economic disparities.

The Potential Role of 16th Finance Commission's:

• Integrating Climate Considerations into Tax Devolution Framework: The 16th Finance Commission has the potential to bring about a transformative shift by integrating climate vulnerability and emission intensity as pivotal factors in the tax devolution formula.
  • This alignment directly supports India's Nationally Determined Contributions (NDCs) under the Paris Agreement, providing states with robust fiscal incentives to actively contribute to national climate goals.
• Implementing Performance-Based Grants for Key Sectors: Recognizing the instrumental role of specific sectors in achieving NDCs and Sustainable Development Goals (SDGs), the 16th Finance Commission could contemplate introducing performance-based grants.
  • These grants, which are specifically designed to help areas like renewable energy, sustainable land and forest management, and air pollution efforts, provide states with focused financial assistance and motivate them to take proactive steps toward change.
• Addressing Emission Reduction Challenges: Prioritizing emission reduction, the commission can focus on decarbonizing critical sectors like energy and transport.
  • This entails incentivizing states to embrace clean energy practices and fostering innovation to tackle persistent issues like crop burning.
  • Through strategic fund allocation, the 16th Finance Commission can drive tangible progress in mitigating emission sources.
• Funding Innovations for Ecological Challenges: Allocating funds to innovative solutions for ecological challenges induced by climate change becomes a crucial role for the 16th Finance Commission.
  • Whether supporting mangrove restoration to counter weather vagaries or addressing the escalating incidents of forest fires, the commission can catalyze research, development, and implementation of sustainable strategies.
• Utilizing Scientific Data for Informed Decision-Making: Leveraging advanced technology, the 16th Finance Commission can utilize scientific data, pollution inventories, and remote sensing to assess state vulnerabilities and mitigation efforts.
  • This data-driven approach ensures that fiscal decisions are rooted in empirical evidence, enabling the commission to design an effective and equitable performance-based system for fund allocation.
• Transforming into a Leader in Climate Readiness: Going beyond its traditional fiscal role, the 16th Finance Commission has the potential to evolve into a leader in India's climate readiness.
  • This transformation involves active participation in designing and implementing a fiscal blueprint that balances economic growth with environmental imperatives, guiding policies that meet present needs without compromising the ability of future generations to meet their own.

Conclusion

In the current juncture where India grapples with the intertwined paths of economic advancement and environmental safeguarding, the Finance Commission's significance in fiscal federalism cannot be overstated.

The 16th Finance Commission, poised to influence tax distribution principles and stimulate climate-conscious endeavours, emerges as a pivotal player in fostering a harmonious equilibrium between economic progress and ecological conservation.

By adopting strategic measures and pioneering innovative strategies, the Finance Commission has the potential to evolve into a formidable catalyst in India's pursuit of climate resilience.