On irregularities in vertical devolution

On irregularities in vertical devolution


Recent agitations in Kerala and Karnataka shed light on issues within fiscal federalism in India.

  • The 16th Finance Commission (FC) needs to address concerns regarding vertical and horizontal inequalities in resource allocation.
  • Two major concerns are the shrinking divisible pool and the rise in tied transfers, highlighting the need for innovative solutions.


GS-02 (Centre- state relations)

Mains Question:

Discuss the recent agitations in Kerala and Karnataka in the context of fiscal federalism in India. (250 words)

Dimensions of the Article:

  • Understanding Financial Devolution
  • Shrinking Divisible Pool
  • Rise in Tied Transfers
  • CAG Indictments
  • Deviations from FC Recommendations

Understanding Financial Devolution:

  • Financial devolution involves the distribution of tax proceeds between the central and state governments.
  • This distribution is based on the recommendation of the Finance Commission, which is constituted every five years.
  • The divisible pool of taxes includes corporation tax, personal income tax, Central GST, and the Centre’s share of the Integrated Goods and Services Tax (IGST). However, cess and surcharge levied by the Centre are not included in this pool.

Shrinking Divisible Pool:

  • The net divisible pool, essential for vertical devolution between the Union and States, faces challenges due to the exclusion of certain taxes from the gross tax revenue.
  • Cesses and surcharges, introduced over the years, have gradually eroded the share of the gross tax revenue available for devolution.
  • Despite expectations that the introduction of the Goods and Services Tax (GST) would streamline taxation, new cesses and surcharges continued to be introduced, further shrinking the divisible pool.

Rise in Tied Transfers:

  • Tied transfers from the Union government to the States, often utilized for centrally sponsored schemes, come with conditions and obligations, limiting the flexibility of State governments.
  • Additionally, capital transfers provided to States are often in the form of loans, adding to their financial burden. This trend of tied transfers undermines the principles of fiscal federalism and fosters a centralized approach to resource allocation.

CAG Indictments:

  • The Comptroller and Auditor General (CAG) has raised concerns regarding the transfer of cesses and surcharges to the respective funds, highlighting instances of non-transfer or short transfer of collected amounts.
  • Such deviations from the prescribed protocol undermine the purpose of collecting cesses and surcharges and reinforce the perception of diverting funds away from the divisible pool.

Deviations from FC Recommendations:

  • Despite recommendations by successive Finance Commissions regarding the share of net proceeds to be devolved to States, the Union government has consistently fallen short of meeting these targets.
  • This shortfall in devolution amounts to a significant sum over the years, indicating a systemic failure in adhering to constitutional mandates.

Way Forward:

  • The 16th Finance Commission must prioritize addressing the challenges of vertical and horizontal inequalities in resource allocation. It should take proactive measures to correct historical imbalances and ensure greater transparency in financial reporting.
  • The Union government must adhere to strict limits on the collection of cesses and surcharges, with provisions for their automatic expiration to prevent circumvention of fiscal norms.
  • Additionally, efforts should be made to provide untied grants to States to compensate for past shortfalls in devolution. By upholding the principles of fiscal federalism, India can achieve equitable and sustainable development across all regions.

Source: TH