Opposition-ruled States, especially southern States, have raised concerns about discriminatory treatment in the current system of fiscal resource sharing between the Centre and the States

Various Opposition-ruled States especially from south India have complained of ‘discrimination’ and ‘unfair’ treatment under the present scheme of sharing financial resources between the Union Government and the States.   

Article 270 of the Constitution provides for the sharing of net tax proceeds collected by the Union government with the States. The taxes that are shared include corporation tax, personal income tax, Central GST (Goods and Services Tax) of CGST, the Centre’s share of the Integrated Goods and Services Tax (IGST), CED on petroleum products excluding the cess and surcharge levied by the Centre etc. All these taxes put together constitute the ‘divisible pool’.

This division is based on the recommendation of the Finance Commission (FC) which is constituted every five years as per the terms of Article 280. At a broader level, the State’s concern has to do with their spending around 60 per cent of the total expenditure (Centre and States put together) even as the share of their tax revenue in total tax revenue is about 40 per cent. For instance, during FY 2022-23, out of total spending of around Rs 100,00,000 crore, the States’ expenditure was Rs 60,00,000 crore, and the remaining Rs 40,00,000 crore was by the Centre. As for the tax collection, out of total proceeds (Centre plus States) of about Rs 50,50,000 crore, the states collected around Rs 20,00,000 crore while the Centre garnered Rs 30,50,000 crore. This doesn’t give the full picture. To get it, we need to add to their tax revenue, the amount of transfer by the Centre from the latter’s tax collection as per the FC formula.

The share of States from the ‘divisible pool’ currently stands at 41 per cent as per the recommendation of the 15th FC. During FY 2022-23, this was Rs 950,000 crore which means tax revenue with the states was Rs 29,50,000 crore and the net amount remaining with the Centre – after transfer to states – was Rs 21,00,000 crore. With this adjustment, the States’ share in overall tax revenue works out to 58.5 per cent which is more or less close to their share in total expenditure at 60 per cent.       

The second concern relates to the cess and surcharge collected by the Centre which doesn’t form part of the ‘divisible pool’ and hence is not shared with the States. During 2017-18 and 2022-23, there has been a 133 per cent rise in the collection of the major cesses and surcharges. In the FY 2022-23, these accounted for a quarter of the total taxes collected by the Centre. The States argue that because of their exclusion, they are getting only 32 per cent of the total tax receipts of the Centre as against 41 per cent recommended by the 15th FC. This shouldn’t be viewed in isolation.

These cesses include a Cess like the GST Compensation Cess (GST – CC). The collections from GST – -CC are used for the repayment of loans taken to compensate States for the shortfall in tax collection due to GST implementation for the period 2017-22. Flowing back to the coffers of the States in its entirety already, it makes no sense to include these collections in the divisible pool. 

An important Cess collected by the Centre is the Road and Infrastructure Cess (RaIC) levied on petroleum products such as petrol and diesel. As is evident from the nomenclature, the collections from this Cess are meant fundamentally for building infrastructure projects mostly national highways, expressways etc. These can’t be made a part of the divisible pool as by sharing with the States thereby reducing the funds available with the Centre, the very objective behind levying the RaIC will be defeated.   

Considering that the cesses and surcharges are levied for a well-defined purpose, including the proceeds from their imposition in the ‘divisible pool’ and then, to argue that the transfer to the states works out to 32 per cent which is lower than the devolution percentage recommended by the FC (read: 41 per cent) is untenable. The fact of the matter is that states are getting their legitimate share in full out of the tax collection by the Centre as per the FC award.      

Apart from the Centre bolstering States’ tax revenue as per the FC devolution formula, it is also helping them on the expenditure side by pumping a sizeable share in the centrally sponsored schemes (CSSs) being implemented by states where its contribution can range from 50 per cent to a high of 90 per cent depending on the Scheme. Besides, the Union government is also helping them by making available 50-year interest-free loans for financing capital expenditure. For the current FY, the loan amount is Rs 130,000 crore.    

A third concern voiced by the southern States in particular, has to do with what they describe as outright discrimination they face in the distribution of the devolved funds among the States (also known in FC jargon as ‘horizontal devolution’). They contend that industrially developed States (all southern States fall in this category) receive much less than a rupee for every rupee they contribute to the Centre’s tax kitty as against States like Uttar Pradesh and Bihar. For instance, Karnataka gets back only 46 paise for every rupee it contributes while Uttar Pradesh gets Rs 1.79 against each rupee contributed by it.

The argument is specious. It sounds like a high-income earner who contributes more to the government’s coffers (that is the way it should be under a progressive tax regime) expecting proportionate benefits from the latter. The proposition suffers from an inherent contradiction. Likewise, a rich state like Karnataka which contributes a rupee as tax should not expect a rupee in return. Successive Finance Commissions have followed this dictum while framing its recommendations.          

The criteria used by the 15th FC for determining the share of states in the divisible pool gives weights to various parameters as under 45 per cent for the income distance; 15 per cent for the population; 15 per cent for the area; 10 per cent for forest and ecology; 12.5 per cent for demographic performance and 2.5 per cent for tax effort. ‘Income distance’ is the distance of a State’s income from the State with the highest per capita income. States with lower per capita income hence, not having the capacity to generate their resources are given a higher share to promote equitable and balanced development. Accordingly, while, ‘income distance’ gets the maximum weight of 45 per cent, population and area get a significant 15 per cent each as these factors put a heavy demand on resources. 

Even as the formula seeks to protect the disadvantaged states, it also gives incentives to states better placed (in terms of per capita income and low population) by giving weight to efforts for controlling their population and improving tax collection efficiency. A 15 per cent weight for these efforts is a good balancing act. Such States also get what is termed as post-devolution revenue deficit (PDRD) grants. These are meant to meet the gap in the Revenue Accounts of the States post-devolution. The eligibility and quantum of grants to concerned states are decided by the FC based on the gap between the assessed revenue and expenditure of the State. The 15th FC had recommended PDRD grants amounting to about Rs 300,000 crore over the five years ending FY 2025-26. To conclude, there is no merit in the argument that the States are treated unfairly in fiscal transfers.

(The writer is a policy analyst, views are personal)