A 30% jump in states’ tax share, yet transfers slow
In this context and keeping in mind the sustainable development goals and balanced regional development, the new commission, to be set up shortly, will among other things decide on the pattern of distribution of the net proceeds of taxes between the Centre and states for the five years beginning April 2026.
A review of the previous FC awards shows that while at an aggregate level, the states’ access to “non-tied” (mandatory and unconditional) central funds increased significantly due to the liberal award from the divisible tax pool by the 14th FC (FY16-20), the intended benefit was curbed by FY20.
The Centre sharply raised non-shareable taxes via assorted cesses on auto fuels. Because of this, the pandemic and the general slowing of tax revenue growth in a sputtering economy, the average annual growth in tax devolution to states in the 14th FC period was 15.8%, the same as in the previous five years (see chart).
And in FY21-24, the first four years of the 15th FC’s six-year award period, the growth in tax devolution slipped further to 13.9% per annum, although the devolution formula remained unchanged. It is worth noting that the states had seen annual growth of 16.5% in tax revenue transfers from the Centre even during the 12th FC period (FY06-10).
That is, despite the states’ share in divisible tax pool being a substantial 10 percentage points (over 30%) higher over the last nine years, compared to the previous five years, and 11 pps higher compared to the five years before that, the states have seen a comparative decline in the annual growth in tax devolution from the Centre in recent years.
Of course, the Centre has been prompt in recent years in releasing the tax amounts to states.
Importantly, the slowing of pace of tax revenue transfers was despite the Centre’s gross revenue receipts in FY21-24 being seen to exceed the 15th FC’s estimate by a fifth, and the public debt reduction outpacing the commission’s road map, which was laid with knowledge of the pandemic on the economy and government incomes.
For sure, to some extent, the slowing of tax transfers pace was offset by the 14% annual growth guaranteed in state-GST revenue under a compensation mechanism for the July 2017-June 2022 period. This artificially boosted the own tax receipts of the states.
A negative fallout of the compensation has been a moderation in “tax effort” by some states. While this seems to get corrected after the compensation period ended, a priority for the new commission, experts say, must be to address any complacency in tax revenue mobilisation on the states’ part.
Another reflection of the problems arising from inadequate revenue buoyancy is the the fact that revenues from GST are still to be restored to the level which the taxes subsumed in GST created in the pre-GST period. While states benefitted from the GST compensation mechanism, now that this cushion is not there, states’ own tax revenues (OTR) are hardly satisfactory, let alone seeing any additional buoyancy due to GST.
The share of cess and surcharge in the Union government’s gross tax revenue (GTR) had steadily risen from around 9% in the 13th FC (FY11-15) to 15% by the end of the 14th FC in FY20. It then rose sharply to over 20% in FY21, the first year of 15th FC award. Thereafter, it moderated a bit as the Centre cut cess on petrol and diesel to stem inflationary pressures in May last year.
Of course, not all cess and surcharges are retained by the Centre in its resource pool. GST compensation cess is shared fully with the states (including repayment cess-linked loans) till FY26, the terminal year of 15th FC.
The higher rate of tax devolution has still resulted in general-purpose transfers going up significantly, but this has also been offset in two ways. Firstly, by the abolition of the Planning Commission, assistance such as Normal Central Assistance, Special Plan Assistance and Special Central Assistance has been discontinued. Secondly, states’ share in centrally sponsored schemes has been enhanced to reduce the support from the Centre.
Many states, mainly opposition-ruled states, have been steadfast in their demand that cesses and surcharges be made part of the divisible pool of central taxes and higher central funding for ‘centrally sponsored schemes’.
The horizontal distribution of shareable tax proceeds is meant to address the issue of equity, but the question is if the pursuit of this goal has indeed started penalising the states that fare better on assorted development parameters. States like Kerala, Karnataka and Tamil Nadu saw their shares in tax pool shrink over the last few decades, while not just poorer states like Madhya Pradesh, but some of the richer ones like Maharashtra and Punjab gain.
States like Bihar rely more on the central transfers for tax revenue, but others like Kerala and Tamil Nadu primarily resort to revenues directly collected by them (own tax revenue).
There has also been a widening of the disparity among states in annual growth rate in the grants in aid received from the Centre. The reformist conditions for release of central grants – performance-based incentives like capital expenditure pace and elimination of loss of power sector– hinder many states’ access to funds.
In many Centrally Sponsored Schemes, the unit costs and the central government’s share of the cost are not in consonance with the ground realities, states argue.
