Syllabus: GS 2/Polity and Governance
In Context
- Recommendations of the Finance Commissions have created friction between States and the Centre.
About Finance Commission
- It is a constitutional body formed by the President of India to give suggestions on centre-state financial relations.
- Article 280(1) of the Constitutions lays down that the modalities for setting up of a Finance Commission
- Currently, 41 percent of taxes collected by the Centre is devolved in 14 instalments among states during a fiscal year.
- The Fifteenth Finance Commission was constituted in 2017.
- The recommendations of the Fifteenth Finance Commission are valid upto the financial year 2025-26.
Roles and responsibilities
- The important tasks of the Finance Commissions are (i)
- To recommend the proportion of the Union tax revenues to be assigned to States and
- To recommend the share of each State in the assigned tax revenue.
Distribution formula
- It devises a distribution formula to arrive at a share for each State, and it is based on the principles of equity and efficiency.
- Equity stipulates that the revenue-scarce States and States with higher expenditures get larger shares of Union tax revenue than others.
- Efficiency is to reward the States that are efficient in collecting revenue and rationalising spending.
- The trade-off between equity and efficiency is normative and remains dynamic in successive Finance Commission recommendations.
Methodology of 15th finance Commission
- Successive Finance Commissions have assigned 10% to 20% weight to income tax revenue collection/assessment in the distribution formula for income tax revenue because collection is not a good indicator of contribution.
- In the 15th Finance Commission, the distribution formula had a tax effort with a weight of 2.5%, and demographic performance, an indicator of efficiency in population control, was given a weight of 12.5%.
- The remaining 85% weight was distributed among equity indicators of per capita income, population as per the 2011 Census instead of the conventional 1971 Census, area, forest cover, etc.
- It introduced the fertility rate in the formula to reward States which had reduced the fertility levels.
Concerns of various states
- Revenue sharing among states is a controversial subject given that there is always a fund crunch and the welfare needs vary.
- This leads to complaints from some states, especially those in southern India, that they get a smaller share, especially considering their contribution to taxes.
- Some States have been arguing that their contributions to the Union tax revenue have been higher than others and, therefore, they rightfully have higher shares in the Union tax revenue.
- Tax contribution is an efficiency indicator because a State’s level of development and economic structure decides its tax contribution.
- However, Finance Commissions had assigned only 10% to 20% weight to this efficiency indicator.
- The Finance Commissions have always favoured assigning more than 75% weight to equity indicators.
Suggestions
- Some states feel ‘cheated’ because of the overuse of the equity criterion.
- Therefore an appropriate balancing of criteria is needed particularly in the context of the rise in unconditional transfers.
- Tax contribution by each State is a good measure of efficiency, and the Goods and Services Tax (GST) regime creates an opportunity for its inclusion in the distribution formula.
- In addition to GST, petroleum consumption is also an indicator of tax contribution to the national exchequer.
- But Due attention needs to be paid to the needs of the lower income States.
- These States are expected to provide a relatively larger share of ‘demographic dividend’ to India in future provided attention is paid to the educational and health needs of their populations
- Instead of using a large number of tax devolution criteria, the transfer of resources to individual States may be guided by the equalisation principle using a limited number of criteria such as population, area and distance, supplemented by a suitable scheme of grants.
- The equalisation principle is consistent with both equity and efficiency.
- The dynamics of the emerging fiscal federalism of India entails significant rethinking especially in the context of the 16th Finance Commission.
| Mains Practice Question [Q] Examine the tax-sharing principles in light of the altered landscape of fiscal federalism in India. |
