Editorial: Of equity and federalism

CHENNAI: Chief Minister MK Stalin recently urged the Centre to increase devolution of central taxes for states to 50%. He was concerned over the decrease in devolution of central funds and increasing financial burden on the state to bear additional expenses for centrally-sponsored projects. Arguing that the onus of formulating and executing programmes pertaining to the development of sectors like health, education, social welfare and agriculture fell upon the states, the CM pointed out that states did not have additional avenues to enhance their revenues to implement such schemes.

Although the 15th Finance Commission had recommended providing states with a 41% share in tax revenue from the divisible pool (vertical devolution), over the last four years, the Centre’s total tax devolution only accounted for 33.16%. The CM’s comments have come at a time when various Opposition-ruled states, especially those from the south, have bemoaned less than proportionate share in tax revenue receipts compared to their contribution towards tax collection. In October this year, the Union government had released Rs 1.78 lakh crore in tax devolution to state governments, including an advance instalment of Rs 89,086.50 crore (in addition to the regular instalment due in October).

A state-wise breakup of the disbursal shows that the highest devolution was made for Uttar Pradesh at Rs 31,962 crore, followed by Bihar at Rs 17,921 crore, Madhya Pradesh at Rs 13,987 crore, and West Bengal at Rs 13,404 crore. Highly industrialised and economically well-off states like Maharashtra, Tamil Nadu and Karnataka settled for devolutions to the tune of Rs 11,255, Rs 7,268 crore, and Rs 6,498 crore respectively. Note that the cess and surcharge collected by the Centre, estimated to be around 23% of its gross tax receipts for 2024-25, does not form part of the divisible pool, and is not shared with the States.

The other aspect of disbursement involves horizontal devolution among the States, which is based on various criteria. These factors include income distance, which is the difference between a state’s income from that of the state with highest per capita income. States with lower per capita income are given a higher share to maintain equity. It’s an important determinant as three decades ago, the gap between rich and poor states was in the order of 3:1. This has now become 6:1. Other criteria include forest and ecology, demographic performance (rewarding states that manage to control their population), tax effort (incentivising states with higher tax collection efficiency).

States generate close to 40% of the revenue and bear 60% of the expenditure. The imbalance must be addressed through an equitable sharing mechanism that prioritises federalism. In a memorandum presented to the Finance Commission, the Tamil Nadu government said the Commission should include new criteria such as contribution to economy and share in urbanisation within the formula for horizontal devolution. Policy experts also believe that the divisible pool should be enlarged by including some portion of cess and surcharge in it. Another point of view is that the Centre should steadily discontinue various cesses and surcharges that it imposes, by fairly rationalising tax slabs. There have also been calls for increasing the weightage for efficiency criteria in horizontal devolution as well as including relative GST contribution from states as a criterion by providing suitable weightage in future FCs.