The calculation of resources available for sharing between the Centre and the states would be difficult in view of the pending changes in commodity taxation at the state level, like the introduction of the value-added tax and other related modifications, C Rangarajan, chairman of the Twelfth Finance Commission, said on Wednesday.

In his address at a function to mark 50 years of Indian finance commissions, Rangarajan said states delivering services more efficiently or raising more revenue relative to their tax bases should not be penalised.

The challenge lay in devising a resource-sharing formula that addressed fiscal disadvantage but penalised imprudence, he said.

Rangarajan also argued for the imposition of user charges. "Whether it be power, transportation, water or municipal services, user charges must be levied to correspond with costs, even though they cannot follow a simple cost-plus formula," he said.

While the tariff or price structure could incorporate some element of cross-subsidisation, it should be ensured that every enterprise at least broke even, he added.

According to him, it is vital to ensure that minimum acceptable standards of select services are available across the country.

"It has been seen that, on average, low-income states spend only half the per-person expenditure of high-income states on social services," he said.

Hence, it was necessary to introduce an element of conditionality while extending grants to states and monitoring their use.

He said the Indian economy was far from achieving the targets set by the Eleventh Finance Commission, which had suggested a revenue deficit target of 1 per cent in 2004-05 for the Centre with states achieving balance on their revenue accounts. The overall fiscal deficit target was set at 6.5 per cent of GDP.

Referring to the over 10 per cent combined gross fiscal deficit of the Centre and the states, Rangarajan said the adverse impact of a large deficit should not be underestimated.

Many studies have highlighted the vicious cycle that is set in motion due to rising debt, interest payments, fall in the growth rate of development expenditure and the consequent impact on economic growth rate.

"However, this is not an argument for balanced budgets or fiscal balance at zero deficit. The fiscal deficit should be maintained at a level at which the adverse impact on the system is minimal," he added.

While conceding the objection raised by performing states that the process of resource transfer was not rewarding good fiscal and developmental performance, Deputy Chairman of the Planning Commission, K C Pant said transfers from the Centre were not the only means of rewarding performance. 

"Good performance gets rewarded by virtue of increased flow of funds from private investors and financial institutions," he said.

Pant also warned that the lack of uniformity in economic and social development would result in growing regional imbalances and lead to growing polarisation, damaging national unity and harmony.

Fiscal federalism needed to address the problem of regional disparity and macro-economic stability with high quality growth and must inculcate some equalisation mechanism so that less privileged states were able to provide reasonable public services to their people, he said.