A fair share (Demand for increased share in central tax devolution), Pg 8

Context:

• Most Indian States have urged the 16th Finance Commission to increase their share in central tax devolution from 41% to 50%, amid concerns over shrinking fiscal space.

Key Highlights:

• 22 out of 28 States have demanded an increase in their share of the divisible pool from 41% to 50%.
• The Centre’s increasing reliance on cesses and surcharges, which are not shareable, has effectively reduced the States’ actual revenue share.
• Share of cesses and surcharges rose from 12.8% (2015–20) to 18.5% (2020–24) of gross tax revenue.
• As a result, States' effective share dropped from 35% to about 31%.
• Post-GST regime has curtailed the States’ own taxation powers, increasing dependency on the Centre.
• Horizontal devolution criteria disproportionately penalise fiscally disciplined and progressive States.

Detailed Insights:

• The current 41% share was set by the 15th Finance Commission and is valid until March 31, 2026.
• The Centre argues that increasing State shares will disrupt its fiscal needs, especially defence and capital expenditure.
• Maintaining 41% would be contrary to the spirit of cooperative federalism.
• Horizontal devolution formula (population + income distance) appears unjust to developed States.
• A modest increase in vertical devolution (e.g., to 45%) could serve as a middle path.
• There’s a need for a mechanism to cap or regulate cesses and surcharges, ensuring transparency.
• Surpluses from such levies should be added back to the divisible pool.
• New criteria for horizontal distribution should account for performance, needs, and area more equitably.

Key Concepts Involved:

• Divisible Pool: The portion of central taxes shared with States.
• Vertical Devolution: Distribution of tax revenue between Centre and all States.
• Horizontal Devolution: Distribution among States based on a set formula.
• Cesses and Surcharges: Tax components levied by the Centre for specific purposes, not shared with States.
• Income Distance: A measure of a State’s income level compared to the highest-income State.

Mains Mock Question:

"Discuss the challenges in Centre-State fiscal relations in India with reference to the role of the Finance Commission. Suggest reforms to make the devolution process more equitable."