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Financial Devolution Among States, Allocation Basis, Challenges

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.


  • 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.

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