Daily Current Affairs for UPSC

Financial Devolution Among States

Syllabus- Economy [GS Paper-3]


Recently various South Indian States raised concerns about their less than proportionate share of receipt in tax revenue as compared to their contribution towards tax collection.

Financial Devolution Among States

  • It is a crucial factor of federalism in India concerning the distribution of financial resources from the Union government to the states, permitting them to meet their expenditure necessities and offer public services.
  • The manner of monetary devolution is guided by the Finance Commission (FC).

The Divisible Pool of Taxes

  • Article 270 of the Constitution offers for the provisions of distribution of internet tax proceeds collected with the aid of the Union Government between the Centre and the States.
  • These consist of organization tax, private profits tax, Central GST, and the Centre’s IGST and so forth.
  • It no longer consists of cess and surcharge which can be levied by-products by the Union Government.
  • States are furnished grants-in-useful resources as according to the advice of the FC, other than the percentage of taxes.

About Finance Commission

  • It is a Constitutional Body [Article 280(1)] constituted every 5 years exclusively with the aid of the Union Government to offer pointers on Centre-State Financial relations.
  • It includes a boss and four other members who’re appointed by the President.
  • The Finance Commission (Miscellaneous Provisions) Act, 1951, has particular qualifications for chairman and other individuals of the commission.

15th Finance Commission

    • It was constituted in 2017 under the Chairmanship of NK Singh, and the recommendations of it are legitimate up to the monetary year 2025-26.
  • 16th Finance Commission:
    • It was constituted on 31.12.2023 with Shri Arvind Panagariya (former Vice-Chairman, NITI Aayog) as its Chairman for making its recommendations in the course of 2026-31.

Role of 15th Finance Commission

    • Vertical Devolution: The FC is responsible for recommending the distribution of the internet proceeds of taxes of the Union among the Union and the States, normally known as vertical devolution.
    • Horizontal Devolution: The FC determines the allocation between the States of the respective stocks of such proceeds, referred to as horizontal devolution.
  • Criteria For Horizontal Devolution:
    • Income distance: It is the space of a State’s profits from the State with the best according to capita profits.
      • States with lower per capita income are given a better share to hold equity among States.
    • Forest and Ecology: The share of forest of each State in the total forest of all the States.
      • Currently, 41% of taxes amassed by the Union Government (as in step with the advice of 15th Finance Commission) is devolved in 14 installments amongst States for the duration of a fiscal year.

Challenges and Concerns

  • Disproportionate Share of Receipt in Tax Revenue: Various Opposition-ruled States, in particular from south India, have claimed that they’ve not been receiving their truthful share as in step with the existing scheme of economic devolution.
    • Cess and surcharge collected by the Union Government is predicted at around 23% of its gross tax receipts for 2024-25, which no longer form part of the divisible pool and therefore not shared with the States.
  • Reduction in Financial Transfers to States: Since the beginning of the 14th Finance Commission term (2015-16), the Union Government has been lowering financial transfers to States.
    • This is specially given that the 14th Finance Commission recommended devolving 42% of Union tax revenues to States, that’s a 10 percentage factors growth over the 13th Finance Commission’s advice.
  • State Wise Variations: The quantity every State gets back for every rupee they contribute to Central taxes suggests a steep version.
    • It can be seen that industrially advanced States obtained a lot less than a rupee for each rupee they contributed as opposed to States like Uttar Pradesh and Bihar.
    • The percent share within the divisible pool of taxes has been reducing for southern States during the last 6 FCs.
    • It is due to the higher weightage being given for equity (income gap) and wishes (population, location and forest) than efficiency (demographic performance and tax effort).
  • Increase in Union Government’s Discretionary Expenditure: The Union government no longer only decreased the economic transfers to States however additionally increased its own total sales to increase its discretionary expenditure.
    • The discretionary expenditures of the Union government aren’t being routed via the States’ Budgets, and, therefore, can impact extraordinary States in distinct methods.
  • Decline in States’ Share in Gross Revenue: One of the reasons for the States’ proportion in gross revenue declining all through this period is that the net tax sales is reached after deducting the sales collections underneath cess and surcharge.
  • Against the Federal Spirit: The Constitutional scheme has usually favoured centre in legislative, administrative and economic family members.
    • However, federalism is a simple feature and it is vital that States don’t feel quick-modified when it comes to distribution of assets.

Way Forward

  • The States generate around 40% of the sales and endure around 60% of the expenditure. It is the duty of all States to make contributions toward the greater equitable development of our country.
  • However, there are 3 essential reforms that may be considered for retaining the balance among fairness and federalism even as sharing sales:
  • The divisible pool may be enlarged by including some portion of cess and surcharge in it.
  • The weightage for efficiency criteria in horizontal devolution needs to be expanded.
  • Similar to the GST Council, a more formal arrangement for the participation of States in the charter and the operating of the FC ought to be considered.

Source: The Hindu

UPSC Prelims Practice Questions:

Q.Consider the following: (2023)

  1. Demographic performance
  2. Forest and ecology
  3. Governance reforms
  4. Stable government
  5. Tax and fiscal efforts

For the horizontal tax devolution, the Fifteenth Finance Commission used how many of the above as criteria other than population area and income distance?

a. Only two

b. Only three

c. Only four

d. All five

Ans: “b”


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