Print Friendly, PDF & Email

UPSC EDITORIAL ANALYSIS : Tax contribution by States needs to be revisited

 

Source: The Hindu

 

  • Prelims: Current events of national importance(Federalism, Finance Commission, Cess and Surcharges, NITI Ayog, etc)
  • Mains GS Paper II & III: Functions and responsibilities of the union and the states, issues and challenges pertaining to the federal structure etc

 

ARTICLE HIGHLIGHTS

  • Chief Ministers expressed their concern about dwindling State revenues in a NITI Aayog meeting chaired by the Prime Minister

 

INSIGHTS ON THE ISSUE

Context

Finance Commission:

 

 

 

The vertical and horizontal dimensions

  • The Fourteenth Finance Commission raised the share of States in the divisible pool of central taxes to 42% from 32%.
    • This was revised to 41% when the number of States in India was reduced to 28.
  • During 2020-21 to 2023-24 (BE): The effective share of States in the Centre’s gross tax revenues (GTR) averaged close to 31%
    • It was significantly lower than the corresponding share of nearly 35% during 2015-16 to 2019-20.
    • The increase in the share of cesses and surcharges to 5(eighteen point five)% of the Centre’s GTR during 2020-21 to 2023-24 (BE) from 12.8(twelve point eight)% during 2015-16 to 2019-20.

Distribution by Finance Commission:

  • The Finance Commission recommends a distribution formula specifying each State’s share in the part of the Union tax revenue assigned to States.
  • Since the 1st Finance Commission, some States have been arguing that their contributions to the Union tax revenue have been higher than others and, therefore, they rightfully have higher shares in the Union tax revenue.
  • In the first eight Finance Commissions, tax contribution with very little weight was a determinant in the distribution formula.
  • Since the 10th Finance Commission, this tax contribution was dropped from the distribution formula.

 

Tasks of the Finance Commissions:

  • To recommend the proportion of the Union tax revenues to be assigned to States
  • To recommend the share of each State in the assigned tax revenue.
  • Till 10th Finance Commission, the States’ share was restricted only to personal income tax and Union excise duties
    • After that, all the Central tax revenues were pooled, and States’ shares were decided.
  • Share of each State in the assigned tax revenue: The Finance Commission devises a distribution formula to arrive at a share for each State, and it is based on the principles of equity and efficiency.
    • Equity: The revenue-scarce States and States with higher expenditures get larger shares of Union tax revenue than others.
    • Efficiency is to reward the States that are efficient in collecting revenue and rationalizing spending.
  • The trade-off between equity and efficiency is normative and remains dynamic in successive Finance Commission recommendations.
  • Successive Finance Commissions have assigned 10% to 20% weight to income tax revenue collection/assessment in the distribution formula for income tax revenue
    • because collection is not a good indicator of contribution.
  • In the case of Union excise duties, the value of taxable products consumed in a State is essential to decide its contribution.

Efficiency Indicator:

  • Tax contribution is an efficiency indicator because a State’s level of development and economic structure decides its tax contribution.
  • Finance Commissions had assigned only 10% to 20% weight to this efficiency indicator.
  • Population, a chief indicator of the expenditure needs of the State
    • It was given 80% to 90% weight in the first seven Finance Commissions as far as income tax distribution was concerned.
  • In the case of distributing revenue from Union excise duties, the entire distribution was based on:
    • Population
    • Area, per capita income
    • Proportion of Scheduled Caste/Scheduled Tribe population
    • Social and physical infrastructure needs.
  • Since the 10th Finance Commission, the Commission has recommended a single distribution formula for both income tax and Union excise duties.

Distribution of Tax Revenue:

  • Since 10th Finance Commission: the formula for the distribution of pooled Central tax revenues included tax effort and fiscal discipline as efficiency indicators(Weight of around 15%).
  • In the 15th Finance Commission, Distribution formula had:
    • Tax effort with a weight of 2.5%
    • Demographic performance, weight of 5%.
    • 85% weight was distributed among equity indicators of per capita income, population as per the 2011 Census.

Definitions:

  • Tax effort: It is the ratio of the own revenue of a State to its Gross Domestic Product.
  • Fiscal discipline is the proportion of own revenue to the revenue expenditure of a State.

GST:

  • GST is a consumption-based destination tax that is equally divided between the State and Central governments.
  • The State GST accrual (inclusive of Integrated GST settlement) to a State should be the same as the Central GST accrual to the Union government from that State.
  • Accurately estimating the tax contribution from a State to the Union exchequer is feasible under GST.

Importance of GST:

  • Since GST is a unified tax system, the calculations show that there is not much of a variation in the tax efforts of States.
  • The absolute amount of GST revenue generated from each State would differ by the size and structure of States’ economies
    • It marks the importance of the inclusion of this tax contribution as an efficiency indicator in the distribution formula.
  • A State’s GST contribution is not affected by discretionary tax policies of the State
    • It only reflects the accurate tax base of the State that is being exploited for the national good.

Way Forward

  • Just like GST, the relative shares of petroleum consumption vary across States, but such shares are stable over time for every State.
    • The relative share of a State’s petroleum consumption reflects the relative contribution of the State to the national exchequer in the category of Union excise duties and customs duties on petroleum products.
  • Including the relative GST contribution and petroleum consumption of a State in the distribution formula.
    • Both these two ratios indicate the relative differences in the incomes (both personal and corporate) accrued to the residents of a State
    • because consumption is a function of income.
  • The share of CGST and Union excise duty is about 30% of States’ share in Central tax revenue in 2021-22 and the similar ratio for personal and corporate income taxes is 64%.
  • The two relative contributions, namely GST revenue and petroleum consumption, of States are fair and accurate measures of States’ contributions to the national exchequer and a good measure of efficiency.
  • There is a persuasive case for the 16th Finance Commission, to debate and include these ratios as a measure of efficiency with a weightage of at least 33% in the distribution formula.

 

QUESTION FOR PRACTICE

How far do you think cooperation, competition and confrontation have shaped the nature of federation in India ? Cite some recent examples to validate your answer.(UPSC 2020) (200 WORDS, 10 MARKS)