On financial devolution among States
- Recently various Opposition-ruled States have claimed that they have not been receiving their fair share as per the present scheme of financial devolution.
Divisible Pool of Taxes
- Article 270 of the Constitution outlines the distribution of net tax proceeds collected by the Union government between the Centre and the States.
- These include corporation tax, personal income tax, Central GST, and Centre's share of the Integrated Goods and Services Tax (IGST).
- However, cess and surcharge levied by the Centre are not part of the divisible pool.
- These taxes are shared based on the recommendations of the Finance Commission (FC) constituted every five years as per Article 280.
- Additionally, states are also provided grants-in-aid as per the recommendation of the FC.
Constitution of the Finance Commission
- The FC, constituted every five years exclusively by the Union Government, consists of a chairman and four other members appointed by the President.
- The Finance Commission (Miscellaneous Provisions) Act, 1951, has specified the qualifications for chairman and other members of the commission.
- Recently, the 16th Finance Commission under the chairmanship of Dr. Arvind Panagariya was formed to make recommendations for the period of 2026-31.
Basis for Allocation
- The share of States from the divisible pool (vertical devolution) stands at 41% as per the 15th FC.
- The distribution among the States (horizontal devolution) is based on various criterias.
- These include income distance, population, forest and ecology, demographic performance, and tax effort.
The Issues
- Cess and Surcharge Exclusion: Approximately 23% of the Centre's gross tax receipts for 2024-25 comprise cess and surcharge, not shared with States.
- Disparity in Returns
- The amount each State gets back for every rupee they contribute to Central taxes shows steep variation.
- Industrially developed States received much less than a rupee for every rupee they contributed as against States like Uttar Pradesh and Bihar.
- This discrepancy is attributed to various factors such as differences in GST collection among various States.
- Reduced Share for Southern States
- The percentage share in the divisible pool of taxes has been reducing for southern States over the past six Finance Commissions.
- This is attributable to the higher weightage being given for equity (income gap) and needs than efficiency (demographic performance and tax effort).
- Variation in Grants-in-Aid
- The Grants-in-aid recommended by FC also vary among States.
- There are revenue deficits, sector-specific and State-specific grants given to various States as well as grants to local bodies.
Recommendations
- The divisible pool should be enlarged by including some portion of cess and surcharge in it.
- The weightage for efficiency criteria in horizontal devolution should be increased.
- Relative GST contribution from States can be included as a criterion by providing suitable weightage in future FCs.
- States should be involved more formally in the constitution and functioning of the FC.
Conclusion
- The implementation of the reforms necessitates collaboration between the Centre and States.
- It also requires ensuring adequate resource devolution to local bodies to facilitate holistic development.