‘41%’ illusion: a quiet re-engineering of India’s fiscal federal landscape, Pg8

Key Highlights:

• The Sixteenth Finance Commission (FC16) recommended retaining the States’ share in the divisible pool at 41%.
• FC16 discontinued revenue deficit grants, sector-specific grants, and State-specific grants.
• The divisible pool as a proportion of gross tax revenues has decreased from 89.2% during the FC13 period to 78.3% during FC15.
• Tamil Nadu estimated a shortfall of nearly ₹20,000 crore in 2024-25 due to the end of GST compensation in June 2022.

Detailed Insights:

• The Union government accepted FC16’s recommendation to maintain the States' share in the divisible pool at 41%, but deferred structural reforms like amending the Fiscal Responsibility Legislation (FRL) and controlling off-budget borrowings.
• The share of cesses and surcharges, which are levied and retained entirely by the Union, has been increasing, leading to a shrinking divisible pool for the States.
• FC16 identified States with unsustainable fiscal trajectories but did not attach binding enforcement mechanisms to achieve reforms.
• The end of GST compensation in June 2022 resulted in States losing a guaranteed 14% annual growth in SGST revenues without a structural replacement.
• Some States borrow through government-controlled entities, keeping these liabilities off the budget, which FC16 recommended discontinuing.
• The replacement of the tax and fiscal effort criterion with a contribution to GDP criterion in the horizontal devolution formula benefits larger, high-GDP States.
• The conditionality architecture of the local body grants, tied to Central monitoring requirements, may disproportionately affect States with weaker governance infrastructure.
• FC16 projects that combined general government debt will fall from 77.3% of GDP in 2026-27 to 73.1% by 2030-31.

Divisible Pool

Key Concepts Involved:

• Divisible Pool: The portion of the Union government's tax revenue that is shared with the States.
• Cesses and Surcharges: Taxes levied by the Union government for specific purposes, not shared with States.
• Fiscal Responsibility Legislation (FRL): Laws enacted to ensure fiscal discipline and reduce government debt.