- 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
- Since the start of the Fourteenth Finance Commission award period (2015-16), the Union government has been reducing financial transfers to States.
INSIGHTS ON THE ISSUE
Context
Finance Commission:
Fourteenth Finance Commission:
- It recommended devolving 42% of Union tax revenues to States, which is a clean 10 percentage points increase over the 13th Finance Commission’s recommendation.
Fifteenth Finance Commission:
- It retained this recommendation of 41%, excluding the devolution to Jammu and Kashmir (J&K) and Ladakh, which were recategorised as Union Territories.
- Including the shares of J&K and Ladakh, it should be 42%.
- The Union government reduced the financial transfers to States
- It increased its own total revenue to increase its discretionary expenditure.
The Finance Commissions recommendations:
- The States’ share in the net tax revenue of the Union government.
- The difference between the gross and the net tax revenue includes:
- collection costs
- tax revenue to be assigned to Union territories
- cess and surcharges.
- Fourteenth and Fifteenth Finance Commissions recommended 42% and 41%, respectively, of the net tax revenue to be the shares of States
- The share of the gross tax revenue was just 35% in 2015-16 and 30% in 2023-24 (Budget Estimate).
- The gross tax revenue of the Union government increased from ₹14.6 lakh crore in 2015-16 to ₹33.6 lakh crore in 2023-24
- The States’ share in the Union tax revenue increased from ₹5.1 lakh crore to ₹10.2 lakh crore between these two years.
- The gross tax revenue of the Union government more than doubled while the share of States just doubled.
- The grants-in-aid to States declined in absolute amount from ₹1.95 lakh crore in 2015-16 to ₹1.65 lakh crore in 2023-24.
- The combined share of the statutory financial transfers in the gross tax revenue of the Union government declined from 48.2% to 35.32%.
Reasons for declining of the States’ share in gross revenue:
- The net tax revenue is arrived at after deducting the revenue collections under
- cess and surcharge
- revenue collections from Union Territories
- tax administration expenditure.
- Revenue collection through cess and surcharge is the highest and increasing.
- The cess and surcharge collection in 2015-16 was 5.9% of the gross tax revenue of the Union government, and this ratio increased to 8% in 2023-24.
- This calculation is excluding the Goods and Services Tax (GST) cess that is collected to compensate for the revenue loss of the States due to implementation of GST.
What are the issues?
- The financial transfers to States either as tax devolution or grants-in-aid decline
- The gross revenue of the Union government the resultant effect is the availability of larger discretionary funds for the Union government to spend.
- This could affect the equity in distribution of financial resources among States.
- The Union government has two routes of direct financial transfers to States, i.e., Centrally Sponsored Schemes (CSS) and Central Sector Schemes (CSec Schemes).
- Between 2015-16 and 2023-24, the allocation for CSS increased from ₹2.04 lakh crore to ₹4.76 lakh crore through 59 CSS.
- The actual financial transfers to States under CSS is only ₹3.64 lakh crore (2023-24), retaining nearly ₹1.12 lakh crore of CSS allocation for other expenses.
- CSS shared schemes: The States that can afford to commit matching finances from the State budgets can avail of the matching grants.
- This creates two different effects in terms of inter-State equity in public finances.
- Wealthy States can afford to commit equivalent finances and leverage Union finances inwards through the implementation of CSS.
- Less wealthy States will have to commit their borrowed finances in these CSS, thus increasing their own liabilities.
CSec Schemes:
- They are fully funded by the Union government in sectors where the Union government has exclusive legislative or institutional controls.
- The allocation for CSec Schemes increased from ₹5.21 lakh crore in 2015-16 to ₹14.68 lakh crore in 2023-24.
- The Union government can allocate financial resources with a motive to benefit specific States or constituencies through the CSec Schemes.
- CSec Schemes are directly implemented by the Union government.
- The combined allocation for CSS and CSec Schemes in 2023-24 is ₹19.4 lakh crore and only ₹4.25 lakh crore is devoted to States.
Way Forward
- The financial transfers through CSS and CSec Schemes are non-statutory transfers as they are based on neither any legal provisions nor any formula determined by the Finance Commission.
- The non-statutory grants are tied grants,e., they have to be spent on specific schemes for which the grants are allocated.
- This reduces the freedom of States in conducting public expenditure.
- Retaining more than 50% of gross tax revenue, the Union government incurs a fiscal deficit to the extent of 5.9% of GDP.
- Thus, the Union government wields enormous financial powers with limited expenditure responsibilities.
- Fifteenth Finance Commission noted that the Union government had argued for the downward revision of States’ share in Union tax revenue from 42% and the Commission retained the share at 41%.
- There may not be a strong case for recommending any further increase in the States’ share of central taxes in view of the Centre’s large fiscal imbalances.
- A re-examination of the role of non-shareable cesses and surcharges is required.
- Set up a loan council(recommended by the Twelfth Finance Commission): This independent body should oversee the loan magnitudes and profiles of the central and State governments.
- The Sixteenth Finance Commission should examine the subject of non-merit subsidies in detail.
- However, exclusion of ‘unjustified’ subsidies while determining grants may cause the Finance Commission to be caught in political crossfire.
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)
