Table of Contents
Context: Recently, Southern Indian states have raised concerns about the unequal distribution of funds under the current financial devolution system.
Divisible Pool of Taxes
- Defined by Article 270 of the Constitution, it includes taxes shared between the Union and States, like corporation tax, personal income tax, and central GST.
- Distribution is based on Finance Commission (FC) recommendations, currently at 41% of the pool going to States.
- Cess and surcharge levied by the Centre are excluded.
Finance Commission
- Constituted every five years by the Union Government as per Article 280.
- Comprises a chairman and four members appointed by the President.
- The qualifications for the chairman and members are specified in the Finance Commission (Miscellaneous Provisions) Act, 1951.
- Recommends allocation of divisible pool and grants-in-aid to States.
- 16th FC under Dr. Arvind Panagariya is working on recommendations for 2026-31.
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Allocation Basis of Financial Devolution Among States
- Vertical Devolution: The 15th FC recommended a share of 41% of the divisible pool for states.
- This marked a slight decrease from the 42% recommended by the 14th Finance Commission.
- Horizontal Devolution: Distributes the divisible pool among States using various criteria:
- Income distance: States with lower per capita income receive a higher share to promote equity.
- Population: Based on 2011 Census data, except in the 15th FC.
- Forest and ecology: Considers the proportion of dense forest in each State.
- Demographic performance: Rewards States with lower fertility rates.
- Tax effort: Encourages States with higher tax collection efficiency.
Challenges
- Cess and surcharge exclusion: Excluding these, estimated at 23% of Union tax receipts, reduces States’ share significantly.
- Unequal returns: Some States get less than ₹1 for every rupee they contribute to Central taxes, highlighting disparity.
- For instance, industrially developed states like Maharashtra and Tamil Nadu often receive less than a rupee for every rupee contributed, while states like Uttar Pradesh and Bihar receive more, reflecting the principles of equity over efficiency.
- Declining share for Southern States: Their percentage share in the divisible pool has been decreasing over the last few FCs.
- Varying grants: Grants-in-aid recommended by the FC differ among States, leading to potential imbalance.
Way Forward
- Expand divisible pool: Include a portion of cess and surcharge, with gradual phase-out of some levies.
- Increase efficiency weightage: Consider State GST contribution as a criterion for horizontal devolution.
- Formal State participation: Establish a more structured arrangement for States’ involvement in the FC.