Finance Commission keeps tax devolution to states at 42%, suggests fiscal deficit glide path

The 15th Finance Commission has recommended that the states be given 42% of the divisible tax pool of the Centre during the period 2021-22 to 2025-26.

The panel's report also provides a range for fiscal deficit and debt path of both the Union and states and also recommended additional borrowing room to states based on performance in power sector reforms.

Finance Commission is a constitutional body that gives suggestions on Centre-state financial relations. The report of the 15th Finance Commission was tabled in the Lok Sabha by Finance Minister Nirmala Sitharaman.

In order to maintain predictability and stability of resources, especially during the pandemic, the 15th Finance Commission has recommended "maintaining the vertical devolution at 41%– the same as in our report for 2020-21," an official statement said. It is at the same level of 42% of the divisible pool as recommended by the 14th Finance Commission, the statement said, adding that however, a required adjustment has been made of "about 1% due to the changed status of the erstwhile state of Jammu and Kashmir into the new Union Territories of Ladakh and Jammu and Kashmir".

As per the glide path, fiscal deficit should be 6% in 2021-22, 5.5% in 2022-23, 5% in 2023-24, 4.5% in 2024-25, and 4% in 2025-26.

The panel, headed by former bureaucrat N K Singh, had in November last year submitted its report titled "Finance Commission in Covid Times" to President Ram Nath Kovind.

The gross tax revenues for a five-year period is expected to be ₹135.2 lakh crore. Out of that, divisible pool (after deducting cesses and surcharges and cost of collection) is estimated to be ₹103 lakh crore, as per the Commission.

States' share at 41% of divisible pool comes to 42.2 lakh crore for 2021-26 period.

"Including total grants of ₹10.33 lakh crore and tax devolution of ₹42.2 lakh crore, aggregate transfers to states is estimated to remain at around 50.9% of the divisible pool during 2021-26 period," it said.

Total transfers (devolution + grants) constitutes about 34% of estimated Gross Revenue Receipts of the Union leaving adequate fiscal space for the Union to meet its resource requirements and spending obligations on national development priorities, the Commission added.

The Commission was asked to give its recommendations on wide-ranging issues. Apart from tax devolution, the Commission was asked to recommend performance incentives for States in many areas like power sector, adoption of DBT, solid waste management etc as well as funding mechanism for defence and internal security.

This report has been organised in four volumes. Volume I and II, as in the past, contain the main report and the accompanying annexes. Volume III is devoted to the Union Government and examines key departments in greater depth, with the medium-term challenges and the road map ahead. Volume IV is entirely devoted to states.

The report provided range for fiscal deficit and debt path of both the Union and states. It also recommended additional borrowing room to states based on performance in power sector reforms.

In view of the uncertainty that prevails at the stage that the 15th Finance Commission has done its analysis, as well as the contemporary realities and challenges, "we recognise that the FRBM Act needs a major restructuring and recommend that the time-table for defining and achieving debt sustainability may be examined by a High-powered inter-governmental group," the statement said. This high-powered group can craft the new FRBM framework and oversee its implementation, it added. It suggested that the Union and state governments amend their FRBM Acts, based on the recommendations of the group, so as to ensure that their legislations are consistent with the fiscal sustainability framework put in place. This group could also be tasked to oversee the implementation of the 15th Finance Commission’s diverse recommendations.

State governments may explore formation of independent public debt management cells which will chart their borrowing programme efficiently, it added.