Are states getting their fair share of taxes?

For the first time in three years, total transfers to states and Union territories from the central government will decline to less than 50% of the Union government’s total budgeted spending for 2019-20.

This development comes amid claims that centre-state revenue sharing is increasingly being skewed towards the centre. This and other issues in financial devolution to the states is highlighted in a new paper by T.M. Thomas Isaac, the finance minister of Kerala, and others, published in the Economic and Political Weekly.

The authors aggregate tax revenues collected by the centre and all states and find that the states’ share in this total was 38% in 2016-17. However, the states’ share in aggregate spending of centre and states is 58%.

According to the authors, this means that the states have greater expenditure obligations with less revenue-raising powers vis-à-vis the centre. This imbalance is further skewed by the imposition of surcharges and cesses, which rise in proportion to the centre’s gross tax revenue and are not shared with the states.

The authors also highlight constraints arising from Fiscal Responsibility and Budget Management (FRBM) Acts, which lay down uniform targets across states and ignores differing fiscal needs. Finally, they express caution regarding the terms of reference of the 15th Finance Commission, which stipulate that future redistribution of state finances be based on Census 2011 figures rather than 1971 figures.

This would be to the distinct disadvantage of states, such as Kerala and Tamil Nadu, that have successfully implemented family planning measures and witnessed a relative decline in their population, the authors argue.

True federalism is only possible through a fair devolution of finances, according to the authors. Therefore, they call for financial devolution to be taken beyond the binary of state-centre with greater decentralization of finances to local governments.

Also read: Challenges to Indian Fiscal Federalism