Wednesday, July 20, 2011

Gadgil - 1

The Gadgil formula is due to D.R. Gadgil, the social scientist and the first critic of Indian Planning. It was evolved in 1969 for determining the allocation of central assistance for state plans in India. Gadgil formula was adopted for distribution of plan assistance during Fourth and Fifth Five Year Plans.

Gadgil Formula

The Gadgil formula was formulated with the formulation of the fourth five year plan for the distribution of plan transfers amongst the states. It was named after the then deputy chairman of the Planning Commission Dr. D R Gadgil. The central assistance provided for in the first three plans and annual plans of 1966-1969 lacked objectivity in its formulation and did not lead to equal and balanced growth in the states. The National development council (NDC) approved the following formula:

1. Special Category states like Assam, Jammu and Kashmir and Nagaland were given preference. Their needs should first be met out of the total pool of Central assistance.

2. The remaining balance of the Central assistance should be distributed among the remaining States on the basis of the following criteria:

(i) 60 per cent on the basis of population;

(ii) 10 per cent on the basis of tax effort, determined on the basis of individual State's per capita tax receipts as percentage of the State's per capita income;

(iii) 10 per cent on the basis of per capita State income, assistance going only to States whose per capita incomes are below the national average;

(iv) 10 per cent on the basis of spill-over into the Fourth Plan of major continuing irrigation and power projects;

(v) 10 per cent for special problems of individual States.
Reasoning behind the given weights:

i. Population

In a country like India population acts as an apt measure to represent the requirements of the people because a major portion of the population lives below the poverty line. This proposition was also supported by the empirical data which showed a negative correlation between population of states and their per capita income.

ii. Tax effort

This is an important factor to measure the potential of the state as far as its own resources are concerned. This relative measure incentivizes the states to undertake measures to increase their own potential through various tax measures.

iii. State per capita income

A problem regarding unequal development amongst the states was faced in the earlier plans because of larger states with their large plans were able to get a larger share of resources from the centre. This led to increased inequalities amongst the states. Therefore, to make the distribution fairer to the smaller states with a lesser than national per capita average income were given extra share in the resources.

iv. Special Problems

This factor was introduced so as to provide enough resources to states to overcome problems like droughts, famines etc. In the absence of this share, such states would have suffered huge losses because of these problems and the implementation of their plans could have been hindered. This was a discretionary element in the formula which required proper scrutiny of the states situation by the Finance Commission.

v. Irrigation and power projects

These projects have been in the process of implementation before the fourth plan was formulated. They needed extra resources for the successful completion of these projects.


The offer of financial assistance from the centre to the states for implementing planned development has been an extremely important matter right from the beginning of the Indian Planning process. The constitution divides the responsibilities between the Union government and the state governments. There was an imbalance between responsibilities assigned to the states and the revenue resources possessed by them to carry out those responsibilities. The transfer of resources for development purposes under the Plans came to be made under Article 282 of the Constitution. The states were highly dependent on the Union government for financing their development plans because the extra resources on which states could bank on were largely concentrated with the Union government.

There was a need for a separate body to look into the division of resources. Therefore the finance commission was appointed in 1951 for the allocation of resources of revenue between the central and the state governments. It was held responsible for examining their liabilities, the resources of the states, their budgeted promises and the effort undertaken to fulfil their commitment. Each five year, the finance commission puts in its recommendations on the proportion of the total collections to be allocated to each of the states. The Planning Commission which was formed soon after the framing of the constitution of India looked into the problems of financing development, which had added to the old problem of financial relations. It came into being because the issue of formulating development plans and implement them efficiently for the development of the economy was not only a very important but also a necessary one. This commission provides for a settlement between the Centre and the states in two categories:

a) Division of revenues

b) Grants in special cases
The centre adds to state resources by conferring fixed percentage of revenue from taxation and from other sources to the states. However, this does not ensure a proper balance in distribution. There are states which are poorer or more backward than the others and therefore require central finances on a much larger scale than the others. This is why recommendations for special grants were introduced. Hence in this manner, the extra resources controlled by the centre were shared with the states to finance the state plans. However, this system in turn induced the states to undertake those schemes in which they got a higher share of the central finances and therefore a steady central assistance was given to the states for a planned period. The grants were supposed to be given to the states which did not have enough capital assets that would have earned them enough money to pay for loans taken from the centre. They were provided to the states outright according to their needs. But in reality, no correlation was found between grants and the need for them.

The first Five Year Plan had provision of only a marginal central assistance which did not play an important part. Due to this, in the second five year plan, substantial importance was given to it. And in the third five year plan, the states had laid more stress on planning and had become critical. In fact, they were given a choice set of various schemes with various proportions of grants and loans attached. This led to an obvious result. The states with larger resources and power could choose schemes with a greater share of grants in them. On the other hand, poor states had to finance almost all their plans by the loans given by the central government. Consequently, there were huge variations in the averages of grants and loans received by the states. A developed state which had resources got 40% as grants; an under-developed state which had no resources got 12% as grants while the average was 22% . The commissions did not have a distinct criteria which was used while allocation of resources. As a result, the states were dissatisfied when they realised that the larger states were getting a bigger share in the pie.

Problems faced

Therefore, in 1965 when the fourth plan was being thought of, the states demanded for a set of firm objective criteria for the distribution of central assistance. The planning commission left it on the states to decide on the criteria. But no agreement was reached in the National Development Council (NDC). Thus, the planning commission thought of an award system, where the finance commission had the discretion to award states in times of need after a proper scrutiny of their situation. In 1968, Planning Commission induced the state governments to come to an agreement. The system of varying proportions of grants and loans from scheme to scheme was abolished. Central assistance to states was now given uniformly in blocks. Each state got 70% loans and 30% grants. There was no special manoeuvrability and therefore no special advantage on the part of the bigger states. This type of settlement also faced problems because of the artificial division between the plan and the non-plan expenditures. The former type of expenditure was to be looked after by the finance commission awards and the latter by central assistance given by either NDC or the Planning Commission. The loan part which was given to the state had gotten accumulated and for some of the states the loan obligation and repayments were bigger than the assistance they got. In 1969, after the draft the fourth five year plan was presented, the Planning Commission officially discussed with the states the impact of the Finance Commission Awards on their finances. Great variations in the provision of these awards were witnessed amongst the states. Some states had a substantial surplus and other states could not even meet their budgetary responsibilities.

Another problem was of the ways and means advances. To overcome the temporary difficulties faced by the state governments, the Reserve Bank of India provided this facility so that the states could balance their balance sheet and remain solvent. This was the extra debt that was to be cleared quickly. After the droughts and famines hit India, states had huge overdrafts year after year. Therefore it was recommended by the Planning commission that resources must first be set aside for meeting the deficits of the states and then help in enabling states to put the new resources into their plans. This was an effort towards bringing non plan and plan expenditures together. This has partially helped in solving the problem of artificial division of expenditures into plan and non-plan expenditures.

The other problem was that the total division of resources did not lead to equality in the development in the states. The larger states with their own resources could have a larger plan and the states with less of own resources at their disposal could only have smaller plans. This led to unequal patterns of development in the country. This problem was partly solved by providing 10% of the total resources to states with lesser per capita income than the national average in the formula. This solution led to two other problems:

The states at the margin suffered a loss due to this as the state, even marginally upper than the national average could not avail of its rightful share
Even after giving no central assistance to certain states, their per capita plan expenditure was larger than those states which entirely depended on central assistance for the finance of their plans. And it was inevitable for the government not to give any central assistance to these states

The Gadgil Formula, though well intentioned, did not achieve much success in reducing inter State disparities. For instance, Andhra Pradesh and Tamil Nadu, which came under the low income category at the time, received below average Plan assistance and Bihar and Uttar Pradesh, just managed to get Plan assistance equal to all the States’ average. Therefore, there was an increasing clamour for modification of the formula, especially from the economically backward states.

Source: Wikipedia

This post talks about the Gadgil formula. Watch out for this space for the modified Gadgil formula.

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