Union Government Releases ₹1.73 lakh Crore to States for Tax Devolution

Syllabus: GS2/ Polity, Centre-State Relations, GS3/Economy

Context

• The Centre released tax devolution of ₹1.73 lakh crore to the state governments to accelerate capital expenditure and finance welfare activities.

About

• A higher amount is being devolved this month to enable states to accelerate capital spending and finance their development and welfare-related expenditures.
• Uttar Pradesh, Uttarakhand and Bihar have received the largest shares of funds.

What is Tax devolution?

• Tax devolution refers to the distribution of tax revenues between the central government and the state governments. 
• Objective: To promote fiscal federalism, strengthen the financial autonomy of state governments, and empower them to meet the needs of their respective populations. 
• Article 280 of the Indian Constitution mandates the creation of the Finance Commission, which determines the formula for devolution of taxes.
  • The central government collects taxes (like income tax, GST, etc.) and a portion is shared with the states based on the Finance Commission’s recommendations.
• Formula Used: States’ share is decided by a formula meant to incentivize demographic performance and each states effort to mobilize its own tax revenue.
  • The formula also takes into account geographic area, forest cover and the state’s per capita income. 
• The Centre also aids States through additional grants for certain schemes that are jointly funded by the Centre and the States.

Current Share of the States

• Recommendations of the 14th FC: It hiked the tax devolution to states to 42% from 32%, and also added a new provision of revenue deficit grants to states facing any resource gap. 
• The 15th finance commission, under the chairmanship of N K Singh has revised tax devolution and brought it down to 41% from 42%. 
  • So the current tax devolution to states stands at 41% till 2026. 
• The 90:10 rule is still applicable to the northeastern and hill states, although there is no special status category. 
• All the other states receive Central funding in a 60:40 ratio, 60% being the Central government’s contribution and 40% states.

Concerns of the States

• Demand for more funds: States argue they should receive more funds than recommended by the Finance Commission.
  • States argue that they have greater responsibilities, including education, healthcare, and policing services.
• Disparities Among States: Developed States like Karnataka and Tamil Nadu feel they receive less money from the Centre than they contribute in taxes.
  • In other words, it is argued that more developed States with better governance are being penalized by the Centre to help States with poor governance. 
• Divisible Pool Concerns: Cesses and surcharges, which are not shared with the States, can constitute up to 28% of the Centre’s tax revenues, leading to revenue losses for States.
• Criticism of the Finance Commission: Critics believe the Finance Commission may not be fully independent due to the Centre’s role in appointing its members, leading to potential political influence.

Way Ahead

• GST and Cooperative Federalism: Strengthening the Goods and Services Tax (GST) framework for smoother tax collection and distribution between the center and states, ensuring a fairer tax system for all regions.
• Improved Tax Administration: Modernizing state tax administration and improving compliance.
• Fiscal Equalization: Ensuring a balanced devolution of resources, considering the economic disparities among states, so that poorer states receive more support.
• Capacity Building: Strengthening the financial management and capacity of states to better utilize devolved funds for development.

Source: TH