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Friction over formula: why some States get more from Centre

GS Paper 2

Syllabus: Issues and Challenges Pertaining to the Federal Structure, Devolution of Powers and Finances up to Local Levels and Challenges Therein


Source: TH


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


Revenue sharing between centre-states:

  • The Indian Constitution grants the Union government more revenue-raising powers while the States undertake most of the development-related responsibilities.
  • Therefore, the Constitution provides for sharing of the Union government’s revenue with the States.
  • The Centre’s tax collections are pooled-in from States and a part of it is distributed among them, based on the Finance Commission’s (FC) formula.


The XVFC formula:

  • 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) – 40% weightage,
    • Equity (per capita income difference) – 45% and
    • Performance (own tax revenue and lower fertility rate) – 15%.
  • The fertility rate in the formula to reward States which had reduced the fertility levels.


Issues in the XVFC’s formula:

  • The XVFC formula is skewed in favour of some States, resulting in wide inter-State variations.
    • For example, for every one rupee that TN gives the Centre, it gets back 29 paise (UP gets ₹2.73 and Bihar gets back ₹7.06)
  • This is because the population is given a higher weightage, rewarding those who have not been able to achieve population control.
  • While the developed States that have lowered their TFR below replacement rate benefit from the drop in TFR, the component’s weight is considerably less.


What do the defenders of the formula say?

  • The objective of the transfer of funds is to enable a State to provide comparable levels of services.
  • The basic rationale is horizontal equity.


What do the southern States say?

  • They have grown faster and contributed larger revenue to the central kitty.
  • Equity should not adversely impact efficiency.
  • Why is the money that goes to poorer States not leading to their development?
  • State-wise HDI and per capita NSDP depict a 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.


Conclusion: The new fiscal federal architecture must be developed via forums like the GST Council, Inter-state Council, and NITI Aayog to accommodate the specific needs and aspirations of states as the dynamics of fiscal federalism change in India.


Insta Links:

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Mains Links:

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