Paper: GS – II, Subject: Polity, Topic: Institutions, Issue: Devolution of Finances to States.
Context:
India’s fiscal framework seeks balance through tax devolution and grants, but states increasingly worry that their fiscal space has been shrinking due to reduced transfers and rising central cesses.
Key Highlights:
Trends in Transfers from Centre to States:
1. Components of Transfers:
- Transfers from the Centre to the states consist of:
- Tax devolution (determined by the FC)
- FC grants (determined by the FC)
- Non-FC grants (at the discretion of the central government)
2. Impact of the 14th Finance Commission:
- It increased the share of states in the divisible pool of central taxes from 32% to 42%.
- States’ share in central taxes relative to the combined revenue receipts of the Centre and the states increased from an average of 15% during the 13th FC period to 19.2% in the 14th FC period (an increase of 4.25 percentage points).
- The post-transfer share of states increased by 4.23%, from 63.85% to 68.08% of combined revenue receipts.
3. Changes during the 15th Finance Commission:
- There was a small fall in states’ total receipts (fiscal space) during the 15th FC period.
- States’ aggregate revenue receipts relative to combined revenue receipts fell from 68.08% in the 14th FC period to 67.39% in the 15th FC period (a reduction of nearly 0.70 percentage points).
- This was primarily due to a reduction in the share of tax devolution by 1.05 percentage points to 18.2% in the 15th FC period.
- The reduction in tax devolution was largely offset by an increase in the shares of both FC and non-FC grants.
- The share of states’ own revenue receipts also fell from 37.72% (14th FC) to 37.35% (15th FC), a reduction of 0.47 percentage points.
- The number of states was reduced to 28 for the 15th FC period.
- The share of non-sharable cesses and surcharges by the central government had been increased.
Fiscal Space of High-Income States:
Recommendations and Conclusion:
Considerations for the 16th Finance Commission:
- The 16th Finance Commission should take into account the concerns regarding the fiscal space available to the states, especially high-income states.
- The weight attached to the distance criterion in the horizontal distribution should be modified.
Role of the Central Government:
- The Centre should refrain from raising non-sharable surcharges and cesses.
Overall Fiscal Health:
- Both the Centre and the states need larger resources to meet multiple challenges.
- Tax receipts of both the Union and state governments must increase.
- A fair system of transfers that strikes a balance between equity and contribution is essential.
Way Forward:
- Ensure states’ fair share in the divisible pool.
- Limit excessive use of cesses and surcharges.
- Strengthen GST revenue flows and expand the tax base.
- Promote cooperative fiscal federalism to protect states’ long-term fiscal sustainability.
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