Context:
Several states, particularly those governed by opposition parties, particularly in southern India, have raised concerns about what they perceive as “discrimination” and “unfair” treatment in the current framework for sharing financial resources between the Union Government and the States.
Relevance:
GS2-
- Centre-State Relations
- Indian Constitution
- Co-operative Federalism
- Constitutional Bodies
Mains Question:
The arguments raised by several states about discriminatory treatment in the current system of fiscal resource sharing between the Centre and the States appear flawed when analysed in depth. Comment. (10 Marks, 150 Words).
Fiscal Devolution:
- Article 270 of the Constitution outlines the mechanism for distributing net tax proceeds collected by the Union government among the States.
- These taxes include corporation tax, personal income tax, Central Goods and Services Tax (CGST), the Centre’s portion of the Integrated Goods and Services Tax (IGST), Central Excise Duty (CED) on petroleum products (excluding cess and surcharge levied by the Centre), and others. Collectively, these taxes constitute the ‘divisible pool’.
- The allocation of these funds is determined by the recommendations of the Finance Commission (FC), which is constituted every five years as mandated by Article 280.
Concerns Associated:
Share in Overall Tax Revenue v/s Share in Total Expenditure:
- The primary concern of the States revolves around the fact that they incur approximately 60 percent of the total expenditure (combined expenditure of the Centre and States), while their share of tax revenue in the total tax revenue is approximately 40 percent.
- For example, in the fiscal year 2022-23, out of the total expenditure of approximately Rs 100,00,000 crore, States spent Rs 60,00,000 crore, while the remaining Rs 40,00,000 crore was spent by the Centre.
- Regarding tax collection, out of the total proceeds (from both Centre and States) of about Rs 50,50,000 crore, States collected around Rs 20,00,000 crore, while the Centre collected Rs 30,50,000 crore.
- However, this data alone doesn’t provide a comprehensive understanding. To achieve a fuller picture, it’s necessary to include the amount transferred by the Centre from its tax collection to the States based on the FC formula.
- The current allocation for States from the ‘divisible pool’ stands at 41 percent, as recommended by the 15th Finance Commission (FC). During the fiscal year 2022-23, this amounted to Rs 950,000 crore, indicating that tax revenue with the states was Rs 29,50,000 crore, while the remaining net amount with the Centre, after transfer to the states, was Rs 21,00,000 crore.
- Accounting for this adjustment, the States’ share in overall tax revenue comes to 58.5 percent, which closely aligns with their share in total expenditure, standing at 60 percent.
Cess and Surcharge Not a Part of The Divisible Pool:
- Another concern relates to the cess and surcharge collected by the Centre, which does not contribute to the ‘divisible pool’ and thus is not shared with the States.
- Between 2017-18 and 2022-23, there has been a 133 percent increase in the collection of major cesses and surcharges.
- In the fiscal year 2022-23, these accounted for a quarter of the total taxes collected by the Centre.
- States argue that due to their exclusion, they are only receiving 32 percent of the total tax receipts of the Centre, compared to the 41 percent recommended by the 15th FC. However, it’s essential to consider the purpose behind these cesses.
- For instance, the GST Compensation Cess (GST-CC) is used for repaying loans taken to compensate States for the shortfall in tax collection due to GST implementation from 2017 to 2022.
- As these funds are already being returned to the States, including them in the divisible pool would be redundant.
- Similarly, the Road and Infrastructure Cess (RaIC), imposed on petroleum products, is specifically intended for building infrastructure projects like national highways and expressways.
- Including these proceeds in the divisible pool and then arguing for a lower transfer to the states contradicts the purpose of levying the RaIC.
- Therefore, considering that cesses and surcharges are earmarked for specific purposes, including their proceeds in the divisible pool and then contesting that the transfer to states is lower than the FC devolution percentage is not reasonable. States are receiving their rightful share in full from the Centre’s tax collection as per the FC award.
- Furthermore, besides bolstering States’ tax revenue as per the FC devolution formula, the Centre also supports them on the expenditure side by contributing to centrally sponsored schemes (CSSs), where its share can range from 50 percent to as high as 90 percent, depending on the scheme.
- Additionally, the Union government provides 50-year interest-free loans for financing capital expenditure, amounting to Rs 130,000 crore for the current fiscal year.
Discrimination in Horizontal Devolution:
- A third concern raised by the southern States, particularly, revolves around what they perceive as blatant discrimination in the distribution of devolved funds among the States, commonly referred to as ‘horizontal devolution’ in Finance Commission terminology.
- They argue that industrially developed States, including all southern States, receive significantly less than a rupee for every rupee they contribute to the Centre’s tax revenue, unlike States like Uttar Pradesh and Bihar.
- For example, Karnataka receives only 46 paise for every rupee it contributes, while Uttar Pradesh receives Rs 1.79 for each rupee contributed by it.
- However, this argument is flawed. It resembles the scenario of a high-income earner who contributes more to the government’s revenue (as it should be in a progressive tax system) but expects equivalent benefits in return. This proposition carries an inherent contradiction.
- Similarly, a prosperous state like Karnataka, which contributes a rupee in taxes, should not necessarily anticipate a rupee in return. Successive Finance Commissions have adhered to this principle while formulating their recommendations.
- The 15th Finance Commission (FC) employs various parameters with assigned weights to determine the share of states in the divisible pool.
- These parameters include: 45 percent for income distance, 15 percent for population, 15 percent for area, 10 percent for forest and ecology, 12.5 percent for demographic performance, and 2.5 percent for tax effort.
- “Income distance” refers to the disparity between a state’s income and the state with the highest per capita income.
- States with lower per capita income, indicating a limited capacity to generate resources, are allocated a higher share to foster equitable and balanced development.
- Consequently, “income distance” receives the highest weight of 45 percent, while population and area are each allocated a significant 15 percent, reflecting their substantial resource demands.
- While the formula aims to support disadvantaged states, it also incentivizes states in better economic positions (in terms of per capita income and low population) by rewarding efforts to control population growth and enhance tax collection efficiency. The allocation of 15 percent weight to these efforts represents a well-balanced approach.
- Additionally, such states receive post-devolution revenue deficit (PDRD) grants to address gaps in their Revenue Accounts following devolution.
- The eligibility and amount of these grants are determined by the FC based on the disparity between a state’s assessed revenue and expenditure. The 15th FC recommended PDRD grants totaling approximately Rs 300,000 crore over the five years ending in FY 2025-26.
Conclusion:
Opposition-governed states, particularly those in the southern regions, have expressed reservations regarding what they perceive as discriminatory practices in the current arrangement for sharing fiscal resources between the Central government and the States. However, as seen above, there are valid points that counter the argument that states are treated unfairly in fiscal transfers.
