Finance commission and the high performing states
Context
Recently, the high performing states like Gujarat, Karnataka, Maharashtra, and Tamil Nadu have demanded an increase in the share of the taxes given to them. It highlights the need to revisit the tax devolution framework.
Relevance:
GS-02 GS-03 (Polity and Governance, Economy)
Dimensions of the Article
- Role of the Finance Commission
- Concerns of the States
- Challenges
Role of the Finance Commission
- The Finance commission determines the tax devolution between the Centra and the States.
- It is constituted once in every five years.
- It recommends the union government on its vertical distribution of funds to different states from its divisible pool of taxes (excluding cess and surcharge).
- It also recommends the horizontal devolution of funds amongst different states.
- The Finance Commission is also responsible for providing grants-in-aid.
- The 15th Finance Commission recommended 41% of the total taxes collected to go to the States.
- The 16th Finance Commission is chaired by Dr Arvind Panagariya, to provide recommendations for the period 2026-31.
- Article 270: It states the distribution of net tax proceeds between the Union government and the States.
Concerns of the States
- Holistically, the major argument from these high performing states is about the limited share of tax revenues that they receive from the Centre, which is not sufficient for their needs. Some of the specific concerns include-
- To increase tax devolution from 41% to 50%, from the central pool.
- As significant portion of tax revenue is collected through cesses and surcharges, it is not considered in the vertical devolution of funds to States.
- Impact on High-performing States: States like Gujarat, Karnataka, Maharashtra, and Tamil Nadu although contribute the most in taxes, it receives very lesser shares due to the formula focusing on equalizing development across poorer regions.
- Industrially developed States like Gujarat, Karnataka, Maharashtra, and Tamil Nadu, despite contributing the most in taxes, receive very less shares due to the formula focusing on equalizing development across poorer regions.
Challenges
- Low Devolution for High-performing States: As the current formula focuses on the poorer regions, the maximum funds from the centre is targeted towards them. And states like Karnataka and Gujrat which are capital intensive, mostly proved in their industrial growth and being top tax contributors, get lesser allocations.
- GST Framework: It is argued that the introduction of the GST has reduced the states ability to collect its own taxes.
- Lack of Support for Natural Disasters: Current formula of the vertical devolution mostly targets the poorer regions. It neglects the need for climate-related expenditure and states which are prone to frequent natural disasters. (Ex: Kerala and Tamil Nadu)
Way forward:
- Increase State Share in Taxes: The vertical formula should be revisited, to ensure that the states who are contributing more are also being given sufficiently. The centre should consider the demand of increasing from 41% to 50%.
- Limit on Cesses and Surcharges: To ensure that more of the taxes collected are shared with the States, the Centre should cap the collection of cesses and surcharges, as these are outside the revenue-sharing framework.
- Address Contingency Needs: In order to ensure that states have the required funds to deal and handle emergencies, the FC should consider including provisions for contingency expenses like natural disasters.
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