Modi tried to force the Finance Commission to cut back on the amount of tax revenue meant for India’s states.

The government of Prime Minister Narendra Modi slashed allocations for different welfare schemes in its maiden budget [File: Rajesh Kumar Singh/AP Photo]

New Delhi, India – Immediately after becoming the prime minister in 2014, Narendra Modi held backdoor negotiations with the Finance Commission of India to significantly cut funds allocated to the country’s states.

However, the head of the commission, an independent constitutional body deciding states’ shares from central taxes, resisted, and Modi had to back off, new revelations show.

The Finance Commission’s firm stance forced the Modi government to hastily redo its maiden full budget in 48 hours and slash funding across welfare programmes since its assumption of retaining a greater portion of the central taxes did not pan out.

At the same time, Modi falsely claimed in Parliament that he welcomed the Finance Commission’s recommendations on the tax portions to be allocated to the states.

These revelations of financial haggling and behind-the-scenes manoeuvring in the making of the federal budget came from BVR Subrahmanyam, the CEO of the government think-tank NITI Aayog. As a joint secretary in the prime minister’s office, he was the liaison in the backdoor negotiations between Modi and the chairman of the Finance Commission, YV Reddy.

This is arguably the first time a top government official in the current Indian government has admitted publicly that the prime minister and his team had tried from the start to squeeze the states’ finances, a concern now repeatedly raised by the states.

Subrahmanyam shared the information while speaking as a panelist at a seminar on financial reporting in India, which had been organised last year by the non-governmental think-tank the Centre for Social and Economic Progress (CSEP).

In his remarks – another first by a government official – he revealed how the federal budgets are “covered in layers and layers of attempt to cover the truth”. He added that he was “sure you will have a Hindenburg who will open up the [Indian government’s] accounts if they are transparent”.

He meant, if the accounts were transparent, the truth of the government’s fiscal condition would become evident, similar to how the Adani Group’s questionable accounting practices were highlighted by US-based short seller Hindenburg Research last year.

Those allegations of accounting fraud and other issues by one of India’s largest business conglomerates led to a $132bn market rout in the group’s valuation and became a political hot potato as the airports-to-cooking oil conglomerate is perceived as being close to the Modi government.

The Reporters’ Collective independently verified Subrahmanyam’s claims against budget and other documents going back a decade.

At one point, Subrahmanyam even divulged details of financial embezzlement and fraud in a government-funded infrastructure project, referring to it as a “funny case”.

Despite his headline-grabbing revelations, the seminar’s YouTube livestream has garnered little more than 500 views. Hours after The Reporters’ Collective sent detailed queries to the Prime Minister’s Office (PMO), public access to the video of the seminar was cut off on the CSEP YouTube channel.

Subrahmanyam, the Ministry of Finance and the PMO did not respond to The Reporters’ Collective’s detailed queries.

The Finance Commission scandal

Prime Minister Narendra Modi tried off-record parleys to get the chairman of the Finance Commission, YV Reddy (pictured), to pare down the revenue share

[File: Anshuman Poyrekar/Hindustan Times via Getty Images]

Per India’s Constitution, an independent Finance Commission, made up of economists and public finance experts, decides what percentage of money the federal government should share with the states from its tax collections, excluding those it labels as “cess” or “surcharges”.

The 14th Finance Commission was set up in 2013. Around the same time, Narendra Modi, as the chief minister of the state of Gujarat, was campaigning for the post of prime minister and made news for asking the commission to give states a 50 percent share of central taxes.

In its report that it submitted in December 2014, the commission recommended that states should get 42 percent of the share of central taxes, up from the 32 percent they had been receiving until then. But Modi, now the prime minister, and his Ministry of Finance, wanted to keep the states’ share of taxes down at 33 percent and a larger portion for the federal government.

Under the constitutional provisions, the government has only two options: accept the Finance Commission’s recommendations or reject them and establish a new commission. It cannot argue, debate or negotiate with it formally or informally.

But the prime minister tried off-record parleys to get the chairman of the Finance Commission, YV Reddy, who was earlier the governor of the Reserve Bank of India, to pare down his recommendations on the revenue share. In his comments on the panel, Subrahmanyam said he was the only other person in that conversation.

This was in breach of constitutional propriety. If the government had succeeded, it would be able to reduce the states’ income while passing the blame onto the constitutional body, the commission.

Subrahmanyam said that a “tripartite discussion between Dr Reddy, me and the prime minister” about the figure took place.

“No Finance Ministry [official or minister],” he stressed, was involved. “Should it be 42 [percent] or 32 [percent] or some number in between? The previous number was 32,” he said, referring to the percentage share of taxes recommended by the 13th Finance Commission.

The conversation lasted two hours, Sabrahmanyam said, but Reddy was unyielding. Subrahmanyam recalled Reddy, telling him in “good south Indian English: ‘Appa [Brother], go and tell your boss [the prime minister] that he has no choice’.”

The government had to accept the Finance Commission’s recommendations of 42 percent.

The Reporters’ Collective verified from an official who was part of the 14th Finance Commission that there had been a delay in accepting the report and conversations about potentially altering it. We corroborated it with another economist who, at that time, was working for the government and in the know about the events.

“It was conveyed that the government had the power to reject the report but not ask for it to be altered. Only once in the past, the federal government has rejected the main report of a Finance Commission and even then it went with the dissenting note that was part of the report. It did not proffer its own devolution numbers,” said the economist, who declined to be named as the discussions involved the prime minister’s office.

But in Parliament, Modi hid his government’s failed attempt to reduce the states’ share of revenues. He told Parliament on February 27, 2015: “To strengthen the nation, we have to strengthen the states… There is a dispute among Finance Commission members. We could have taken advantage of that. We didn’t. But it is our commitment that states should be enriched, should be strengthened. We gave them 42 percent devolution.”

He added, “Some states would not have treasuries big enough to keep all this money,” as members of Modi’s ruling Bharatiya Janata Party (BJP) laughed and applauded.

The Modi government slashed outlays for welfare schemes impacting children [File: Jayanta Dey/Reuters]

But with a smaller portion of the tax revenue, the government had to rehash the entire budget and ended up slashing allocations for several welfare schemes.

“The budget was written in two days that year. Two days because this recommendation is accepted so late, so late and everything was written at that time … in a conference room in NITI Aayog. Four of us sat and actually recast the entire budget,” Subrahmanyam recounted.

“I still remember when we were cutting off … women and child – state subject – 36,000, make it 18,000 crores,” he said in his speech, recounting how he and three other unnamed officials halved the allocation from 360 billion rupees ($5.8bn) to 180 billion rupees ($2.9bn) for the central Ministry of Women and Child Development, which runs welfare schemes like delivering hot cooked meals to children, pregnant women and lactating mothers.

While the numbers he rattled off were not precise, the government did significantly cut allocations by nearly half from 211 billion rupees ($3.4bn) in the budget for the financial year ending March 2015 to 102 billion rupees ($1.6bn) the next year after it had to accept the higher proportion of payment to the states.

The budget also saw an 18.4 percent cut in allocation for school education from the previous year.

‘Attempt to cover the truth’

Subrahmanyam’s candid remarks stand out all the more because it is quite rare for government officials, particularly in the Modi administration, to be so forthcoming.

Speaking on the panel on fiscal transparency – how honestly the government lays out its revenues and liabilities – Subrahmanyam said it would take a “Hindenburg” to delve into the country’s accounts. A chuckle of acknowledgement rippled across the conference room.

The federal budget is “covered in layers and layers of attempt to cover the truth”, he said. Analysis of budgets by the likes of JPMorgan and Citibank “actually unveils the truth in what the real situation is”, he said, referring to how foreign banks and investors are more honest than domestic players in their analyses of the Indian government’s accounts.

Subrahmanyam added that the budgets of the states and federal government were untrustworthy as governments at both levels were using accounting tricks and sometimes plain fraud to avoid revealing the levels of debt.

One of the key concerns of domestic and international investors is the level of fiscal deficit the government carries at any given time – how much it is spending in excess of what it earns from taxes and other revenues, through borrowings. In other words, living beyond its means. Unhealthy levels of fiscal deficit scare away investors and can lead to a negative cascading effect on the economy.

Governments, therefore, try accounting tricks to meet their expenses from borrowings that can be kept out of budget documents, better known as “off-budget borrowing”.

BVR Subrahmanyam, the CEO of NITI Aayog, said state and federal government accounts were full of accounting tricks [File: Qamar Sibtain/India Today Group/Getty Images]

Indian governments of all hues have been criticised in the past for doing this. These, simply put, are loans, usually taken by the likes of government-owned companies, which are not reflected in government accounts, even though, ultimately, it is the government that has to repay these loans.

In its fiscal year 2019-20 budget, the federal government announced that going forward, it would disclose all such off-budget borrowings. This came on the heels of criticism from the 15th Finance Commission against the rise in such borrowings.

It did disclose better than it had so far, but as Subrahmanyam admitted, it was not enough.

“It is disclosing only one part,” he pointed out in his speech, referring to the government’s statement on extra-budgetary resources. “What is the time of the borrowing, amount of borrowing, timeline of the borrowing, interest rate? Nothing is known.”

A report on the federal government’s finances by the country’s comptroller and auditor general, exposed some of these deficiencies in 2022. It, for instance, did not disclose the more than 1.69 trillion rupees ($21.9bn) raised by different government-owned bodies, which should have been part of the budget statement on extra-budgetary resources.

In his comments, Subrahmanyam also delved into a case of financial misconduct in a government-funded infrastructure project in the erstwhile state of Jammu and Kashmir when it was under the direct control of the federal BJP government.

“We had a funny case,” he said and narrated how the Jammu and Kashmir administration, at the time under the direct control of the federal BJP government, submitted a “fake UC”. This referred to utilisation certificates, the official document certifying that funds have been used for the purpose for which they were disbursed.

The federal government sends funds to states for infrastructure projects in tranches. The money for each subsequent tranche is released after the state sends a certificate that it has used the previous tranche for the right purposes.

“The second instalment came in. The contractor who has taken the first instalment, nobody knew how to pay him. Because the first instalment technically is consumed and the second has come up,” he added.

In other words, based on the fake utilisation certificate that had been submitted, the federal government sent the second tranche of funds. But now, the Jammu and Kashmir administration was stuck with it. It had misused the first instalment of funds and it could not afford to pay the contractor partially.

The Reporters’ Collective did not receive a response from Subrahmanyam and the Finance Ministry on detailed queries regarding the legality of this practice.

Cesspool of surcharges

Once the Modi government found it could not reduce the state’s share of taxes by getting the Finance Commission to change its report, it exploited an old accounting manoeuvre that persists to this day. The federal government steadily increased the collection of a class of taxes called cess and surcharges. States are not entitled to any portion of this.

“There is an increasing use of cesses and surcharges to fund or to raise revenues,” Subrahmanyam said in his speech.

The amount of cess and surcharges collected by the federal government under Narendra Modi has grown since 2015, data shows.

The share of cesses and surcharges stood at 10.4 percent of total taxes collected in 2011-12 by the Congress-led federal government. Between 2017-18 and 2021-22, the total cess and surcharge collected by the federal government more than doubled, from 2.66 trillion rupees ($33.7bn) to 4.99 trillion rupees ($64.8bn). During that period, cesses and surcharges rose from 13.9 percent to 18.4 percent as a share of gross tax revenue.

Malini Chakravarti of the independent think-tank Centre for Budget and Governance Accountability writes about the tricks the BJP government deployed to up its share of monies at the cost of the states: “In the 2017-18 budget while the Centre reduced the tax rate of incomes up to Rs 500,000 [$7,400] from 10 percent to 5 percent, it levied a surcharge on incomes above Rs 5 million [$74,600] to counter the resultant revenue loss. Similarly, in the 2018–19 budget even while excise duty on petrol was reduced by Rs 9 [$0.12] per litre, the road cess was increased by an equivalent amount.”

Referring to the rise in cesses and surcharges, Subrahmanyam said: “So, if that is the case and these are part of the non-divisible pool, then states would be wary of ceding more and more of their autonomy in taxation.”

One such way the Modi government eroded the state’s tax resources was through a national goods and services tax (GST), which was introduced in July 2017 after years of political haggling. It was supposed to create a single market, replacing a plethora of local taxes with national ones. But “states are being increasingly choked for revenue,” Subrahmanyam said, echoing a concern that has previously been voiced by opposition-ruled state governments.

Research papers in the recent past have shown that state tax revenues post-GST have declined when compared with the pre-GST period.

A January 2023 paper by researchers at the National Institute of Public Finance and Policy analysed state revenues and found that in 17 out of 18 states they reviewed, the revenue that states generated through state-level taxes declined in the post-GST period compared with the pre-GST period when seen as a percentage of the gross state domestic product (GSDP).