Explained: Special category status to Bihar, Andhra will open a pandora’s box

Special category status
Special category status offers financial aid to a few states, creating an uneven playing field for others.

After the BJP failed to secure a majority on its own in the Lok Sabha Election 2024, the party is dependent on its two allies, Janata Dal (United) and Telugu Desam Party, both of whom have demanded special category status for their respective states. If the BJP yields to their demand, other states may join the chorus. While the JDU stated that its support for the Narendra Modi government was unconditional, it still seeks special category status, deeming it essential for Bihar’s development.

Andhra Pradesh’s demand is not new. In 2018, the BJP and TDP clashed over central assistance, with the TDP alleging that post-bifurcation, Andhra Pradesh received a raw deal and lacked resources. The demand for special category status has persisted since Telangana’s inception in 2014. In 2018, Chandrababu Naidu’s TDP exited the NDA when the special status was not granted.

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What is special category status

The concept of special category status for states was conceived in 1969 by the Fifth Finance Commission to provide historically disadvantaged states with preferential treatment, including additional central assistance and tax breaks. Criteria included difficult terrain, low population density, significant tribal population, strategic locations, economic and infrastructural backwardness, and non-viable state finances.

Initially, Assam, Nagaland, and Jammu and Kashmir received this status, later extended to states like Arunachal Pradesh, Himachal Pradesh, Manipur, Meghalaya, Mizoram, Sikkim, Tripura, and finally Uttarakhand in 2010. These states benefited from concessions in excise and customs duties, income tax rates, and corporate tax rates, receiving up to 90% grants under central assistance.

However, the Constitution has no provision for categorising any state as a special category state. The Fourteenth Finance Commission discontinued this status. The Fifteenth Finance Commission attempted to compensate states through higher tax devolution or state-specific grants. The demands from Bihar and Andhra Pradesh are challenging as the government’s focus is on fiscal consolidation and debt reduction.

The Fifteenth Finance Commission suggested that rather than granting special status to states, poorer states with special needs should receive help. If many states make such requests, the Niti Aayog should consider creating a special financing window based on specific criteria. If special status is granted to one state, others like Jharkhand and Odisha may follow suit. Odisha was previously denied special status as it did not meet the criteria.

In March 2023, the finance ministry clarified that an inter-ministerial group found Bihar’s request for special category status inapplicable based on existing criteria. In the case of Andhra Pradesh, the then finance minister Arun Jaitley offered the monetary equivalent of a special category state, but could not grant the status itself, which was limited to northeastern and three hilly states by the Fourteenth Finance Commission.

Several economists and policy makers have explained why the status was not viable. While in February 2014, the then Prime Minister Manmohan Singh promised special category status to Andhra Pradesh for five years, concerns arose within the government regarding the fiscal and constitutional implications of such a commitment. Other states, like Tamil Nadu, protested that tax incentives for Andhra Pradesh would create an uneven playing field.

Granting special category status to Andhra Pradesh and Bihar could significantly increase Union government’s spending, as these states would be eligible for more central grants. If the government increases the overall size of central schemes, the fiscal deficit may not be significantly affected. However, if existing schemes remain unchanged, other states will receive less funding. Extending special status to external agency loans would directly impact the government’s deficit, reducing the amount available for other states.

A report by the Raghuram Rajan Committee identified Bihar and Odisha as the least developed states and proposed a new methodology for fund allocation based on need and performance, suggesting the elimination of the special category approach. This proposal was never implemented.

The Sixteenth Finance Commission will need to carefully analyse the potential impact of granting special category status to Andhra Pradesh and Bihar on overall fund distribution. The Sixteenth Finance Commission will recommend the formula for sharing taxes and other funds between the Centre and states for five years starting April 1, 2026.