15th Finance Commission cuts states’ share of central taxes to 41% vs 42%

The 15th Finance Commission (FCC), in its interim report for 2020-21, had reduced the share of states in the divisible pool of central taxes by one percentage point to 41%, factoring in the conversion of the erstwhile state of Jammu and Kashmir into two Union territories.

The report, tabled in Parliament on Saturday by the finance minister, also tweaked the criteria and weights under which funds are allocated to states.

It assigned 15% weight to the population of a state, down from the 17.5% allocated by the 14th Finance Commission, but raised the weight under demographic performance from 10% to 12.5%.

The FFC report has introduced a new criteria, the “tax effect”, for states, with 2.5% weightage, while significantly reducing the weight for income distance from 50% to 45%.

Consequent to the recommendations of the FFC, the tax share of most southern states, including Andhra Pradesh, Kerala, and Karnataka, has come down, while the share of Bihar, Madhya Pradesh, Punjab, Maharashtra, and Gujarat has gone up.

The commission deferred taking a call on the contentious defence and internal security fund proposed by the Centre.

“We acknowledge the criticality of the additional ToR asking us to examine whether a separate mechanism for funding defence and internal security is to be set up. There is merit in ensuring a predictable and stable flow of funds for defence and internal security and this will receive appropriate consideration in our final report,” the report said.

The term of the N.K. Singh-headed FFC was extended by a year in November and the panel is expected to present the final report covering financial years 2021-22 to 2025-26 by 30 October.

Aditi Nayar, principal economist, and Jayanta Roy, senior vice president, Icra Ltd, wrote in a note that 10 out of India’s 28 states have seen a reduction in their share in central tax devolution, according to the interim report of the FFC for FY21. “These states will need to carefully assess their revenue situation,” they said.

The FFC, while determining the vertical devolution, has effectively reduced the share of states from 42%, which was applicable for 29 states, to 41%, which is applicable to 28 states, said D.K. Srivastava, chief policy advisor, EY India. “This is because of the rounding off of Jammu and Kashmir’s share, which was 1.854% in a total of 100%, which amounts to close to 0.8% out of 42%. This rounding off works marginally in favour of the Centre,” he said.