In today’s Finshots, we talk about the economics of according the “Special Category Status” to a state and why Bihar and Andhra Pradesh are asking for it.

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Now, on to today's story.

The Story

India just formed a new government a few days ago. And with all of the buzz around the election, there's some new talk in town ― “Special Category Status” or SCS for states.

Think of SCS as a status that makes economically or geographically challenged states eligible for some extra financial support from the central government. This could be in the form of a higher share of funds from its central kitty and/or additional tax benefits.

It started way back in 1969 when the then Finance Commission felt that a move like this could help India’s border states (who constantly had to live with the fear of infiltration), economically backward states, states with a sizable tribal population or even newly carved out ones that would need some time to transition.

And right now, there are two states that think that they fit the bill.

To begin with, you could look at Bihar, one of the long contenders of the SCS.

Most of its economic output comes from agriculture, an activity highly vulnerable to droughts, floods and other natural disasters. And limited industrial development compared to other Indian states, means that folks in Bihar have limited job opportunities beyond agriculture itself.

Thanks to past policies like Freight Equalisation, which ensured that the central government subsidised the transportation of minerals and raw materials to a factory set up anywhere across India. This meant that a tonne of coal would cost the same in a place like Bihar from where it was mined or in Mumbai (then Bombay) where it was used. It incentivised companies to set up industrial locations closer to the coastal trade hubs or markets in other parts of the country, leaving states like Bihar behind.

Carving out Jharkhand off from itself over two decades ago was another nail in Bihar’s coffin. It lost whatever little was left of its industries and mineral resources.

That explains why Bihar today is India’s poorest state in terms of how many people have access to cooking fuel, electricity, homes and bank accounts. Despite pulling out nearly 7% of its people from poverty between 2021 and 2023, nearly a third of its population still remains poor.

This sorry state of affairs seeps into the state’s finances too. It hasn’t been able to up its educational infrastructure, improve its low literacy rates or even its healthcare facilities because the government can’t really make much money off of taxes or other revenues from its poor population. For context, just about 30% of its revenues come from its own taxes. This implies that it has to heavily rely on transfers from the central government to keep its economy ticking.

Then you have Andhra Pradesh, another state in the SCS queue. Its economic situation isn’t as bad as Bihar’s. But losing Hyderabad, its central economic hub to Telangana, which was carved out of it a decade ago, meant losing significant revenue sources and a skilled workforce. Most of its projects and development came to a standstill. And it also fell short of funds to build its new capital, Amaravati. And this imposed a huge financial strain on the state, widening its debt to about 30% of its state income or Gross State Domestic Product (GSDP) from about 24% when Telangana was still part of it.

And these two states think that SCS can be a magic spell that can pull them out of the realms of poverty and debt.

But here’s the thing. 2014 marked the end of the SCS. And that meant that leaving out the 11 states of Jammu & Kashmir (now a Union Territory), Himachal Pradesh, Uttarakhand and all the North Eastern states that already enjoyed the SCS, the government wouldn’t freshly confer this title to other states anymore.

The reason to halt this privilege was simple. SCS isn’t something the government can offer for a short while. It’s a long term commitment. Because if states got a taste of it, they’d come back asking to continue the benefits until they were stable enough to run their economic engine on their own. And that would add up to the central government’s expenditure, taking a toll on its finances.

Instead, the central government was ready to share more of its revenues with states. Simply put, it earlier divided 32% of the money it made through taxes and other income with them. But it now upped that to 42%*. Not just that. If states suffered a financial crunch and they couldn't spend on development, the centre would even offer a grant to make up for the shortfall.

So why aren’t Bihar and Andhra Pradesh happy with that offer, you ask?

Well, you see, a SCS could mean that 90% of the funds they need to run centrally sponsored schemes would come from the centre’s coffers, as opposed to just 60% for other states. We’re talking about schemes like the mid day meals to underprivileged school children, employment guarantee for rural folks or even the National Health Scheme. States will only have to put in 10% of their money to keep these schemes running. They can even carry forward unused funds to the next year, something other states aren’t allowed to do.

And the best part? SCS states even enjoy tax concessions that might attract more companies to set up shop there.

A one-time financial grant won’t come with the same benefits. The higher tax devolution that the central government offered wasn’t going to solve the problem either, because it’s something all states would share. And that made it seem like only a SCS could turn the fortunes of states that aren’t able to cope economically.

But wait… If the SCS can’t be freshly doled out to states anymore, then how can states even vie for it?

They can, simply because here’s what we didn’t tell you earlier.

One of the reasons behind discontinuing the SCS in 2014, was that the central government abolished the Planning Commission and replaced it with the NITI Aayog. While the Planning Commission was a body that had the authority to impose policies on the centre or states and even allocate funds between them, the NITI Aayog was just a think tank, whose role was limited to advising the government.

This meant that it was now optional for the government to allot states the coveted SCS. And if it wants to, it can always take advice from the NITI Aayog and revisit this arrangement. Doing that though, can be an expensive affair. And that’s why it keeps telling states that they can’t get a SCS tag because the Planning Commission doesn’t exist anymore.

But with a coalition government at the helm after a decade and the states of Bihar and Andhra Pradesh having more say, will the SCS debate be reignited once again?

We’ll only have to wait and see. Until then…

*Currently, India shares 41% of central taxes with states. But around the time SCS was discontinued, it shared 42%.

Note: The Story has been updated to mention the context of the percentage of tax devolution between the centre and the state. Also, an earlier version of the story mentioned that the Planning Commission was a constitutional body. But the Planning Commission was actually an extra constitutional body, not mentioned in the constitution. We regret the error.

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