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16 March 2023: Revenue Sharing Formula between States and The Centre

With the population given a higher weightage over performance, the revenue-sharing formula has created friction between States and the Centre

Why in the news?

According to the latest recommendations of the XVth Finance Commission, chaired under N.K.Singh, the state’s share of the tax devolution and the weightage criteria for the same are not necessarily good for each of the states in India. 

Based on principles of need, equity and performance, the overall devolution formula is as follows:

 Vertical devolution:

  • In order to maintain the predictability and stability of resources, especially during the pandemic, XVFC has recommended maintaining the vertical devolution at 41 per cent – the same as in our report for 2020-21. 
  • It is at the same level of 42 per cent of the divisible pool as recommended by FC-XIV. However, it has made the required adjustment of about 1 per cent due to the changed status of the erstwhile State of Jammu and Kashmir into the new Union Territories of Ladakh and Jammu and Kashmir.
  • In XVFC’s assessment, gross tax revenues for the 5-year period are expected to be 135.2 lakh crore. Out of that, the Divisible pool (after deducting cesses and surcharges & cost of collection) is estimated to be 103 lakh crore.
  • States’ share at 41 per cent of the divisible pool comes to 42.2 lakh crore for the 2021-26 period.
  • Including total grants of Rs. 10.33 lakh crore (details later) and tax devolution of Rs. 42.2 lakh crore, aggregate transfers to States is estimated to remain at around 50.9 per cent of the divisible pool during the 2021-26 period.
  • Total XVFC transfers (devolution + grants) constitute about 34 per cent of the 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.

What’s the issue?

The Centre’s tax collections are pooled from States and a part of it is distributed among them, based on the Finance Commission’s (FC) formula. The Fifteenth Finance Commission’s (XVFC) formula is skewed in favour of some States, resulting in wide inter-state variations. As the population is given a higher weightage, it tilts the balance in favour of some northern States. This has been a bone of contention between the Centre and the affected States. 

  • For every rupee that Tamil Nadu gives the Centre, it gets back 29 paise.
  • On the other hand, Uttar Pradesh gets 2.73, and Bihar gets back 7.06
  • The XVFC had arrived at the States’ share in the divisible pool of taxes based on each State’s needs (population, area and forest and ecology), equity (per capita in- come difference) and performance (own tax revenue and lower fertility rate).
  • The weight assigned to needs was 40%, equity 45%, and 15% to performance. This formula meant that Uttar Pradesh and Bihar got 17.9% and 10%, respectively in the XVFC.
  • Karnataka, Kerala and Tamil Nadu got 3.65%, 1.93% and 4.08%, respectively.
  •  In successive FCs, the share of southern States has seen a consistent decline. Notably, the XVFC introduced the fertility rate in the formula to reward States which had reduced the fertility levels 
  • While this does favour the developed States which have pushed their TFR below replacement rate, the weightage given to the component is relatively lower than equity and need
  • State Wise per capita NSDP depicts this trend where States which get more money from the Centre show sedate growth, and the progress of those who get less is relatively much superior.

 

Source – The Hindu and Press Information Bureau