White Paper on Indian States (1950)/Part 9/Financial Adjustments on Revenue Account

by Ministry of States, Government of India

Financial Adjustments on Revenue Account

196. This was one of the most important subjects dealt with by the Committee. The main object was the avoidance of sudden dislocation of the finances of the States or of the Centre as a result of federal financial integration. The technique suggested for this purpose was as follows:

(1) A computation should be made of the revenue from "federal" sources and from internal customs duties which each State would lose, and of the "federal" expenditure which it would save as a result of federal financial integration. For this purpose the "privy purse" payable to Rulers under the Covenants entered into with them should be regarded as expenditure to be borne by the Centre, if it were subsequently decided (as has now been done) that they should be a "federal" liability under the new Constitution.

That the loss of revenue to the States should be measured by the average of such revenue during the three completed financial years of the State immediately preceding 1st April 1950; and the saving of expenditure should be measured by the expenditure on federal subjects actually incurred by the State in only the last of such years, where reliable accounts for earlier years were not available, as in the case of five Unions of States, the loss of revenue was to be measured, except as regards Railway revenue, on the basis of one year only.

These recommendations have been accepted by all States, with the modification that instead of a three-year average for revenues, a two-year average would be taken. Certain other minor modifications affecting the computation of particular items of revenue were also made.

(2) The loss of revenue from internal customs duties should be wholly borne by the States, except where such duties were to be entirely abolished on 1st April 1950.

This recommendation was accepted by all States.

(3) As regards "federal" revenues, properly so called, the net loss (or profit) to a State resulting from federal financial integration was to be computed by setting off the 'federal' expenditure saved against the 'federal' revenues lost.

(a) If the result was a net profit to the state i.e., if the saving in expenditure on federal subjects exceeded the loss of federal revenues (as in the case of Vindhya Pradesh, Rajasthan, Madhya Bharat and PEPSU), the adjustment suggested was the recovery by the Centre from the State of the amount of such profit (limited to the amount of the privy purse) over a period of 10 years in diminishing amounts, viz., 100 per cent. in the first year, 90 per cent. in the second year, 80 per cent. in the third year, and so on until there would be only a 10 per cent. recovery in the 10th year and none in the eleventh year.

This recommendation has been accepted by the States concerned with the modification in the case of Madhya Bharat and Rajasthan, that the recovery would be spread over 5 years only (diminishing by 20 per cent. per annum), in view of the increasing income-tax revenue likely to accrue from these States.

(b) If the result was a net loss to the States i.e., if the loss of federal revenues exceeded the saving in expenditure on federal subjects (as in the case of Tranvancore-Cochin, Mysore, Hyderabad and Saurashtra), the adjustment suggested was that the Centre should guarantee to reimburse the whole of such loss for the first five years, and thereafter the Centre's reimbursement guarantee would be of diminishing amounts over the next five years, with no guarantee in the eleventh year. The diminution in each year, from the sixth to the tenth, would be one-fifth of the amount by which the original net loss of "federal" revenues exceeded 60 per cent. of such original net loss plus the whole of the loss of revenue from internal customs duties.

This had the result (as in the ease of Travancore) that there would be no diminution of the Central gaurantee in any case in which the net loss of "federal" revenues alone was 60 per cent. (or less) of the aggregate of such loss and the loss of internal customs duties taken together.

The above guarantee scheme was qualified in two important directions, firstly, in each year (1950-51 to 1959-60) the State concerned was entitled to receive either the guranteed amount or its share of the divisible federal taxes whichever may be higher; and secondly, there would be no guarantee from 1960-61 onwards.

This recommendation has been accepted by the four States concerned, with one important qualification in the case of Travancore-Cochin. That State will receive in the first three years (1950-51 to 1952-53) a further guaranteed sum equal to the amount by which its actual federal revenues of the year ending 16th August 1949 exceeded the average of such revenues during the two years ending 16th August 1949. This concession was necessitated by the need to give some compensating advantage as against the heavy loss resulting from the immediate total abolition of all internal customs duties.