India needs a scheme to achieve a fair distribution of resources so that states with an aging population will not be disadvantaged economically.
Published Mar 31, 2025 | 9:00 AM ⚊ Updated Mar 31, 2025 | 9:00 AM
The southern states that have successfully implemented the family planning programmes, now face the twin problem of a declining replacement ratio and an aging population.
Synopsis: The southern states bear a disproportionate share of the aging population with one-fifth of their population in the above 60 age group. Such a situation requires a re-evaluation of the existing fiscal frameworks, with the distribution of resources being adjusted to the new population realities and pressing socio-economic concerns.
Political equity in Indian federalism — mainly proportional representation for states in Parliament against the backdrop of the planned delimitation of constituencies — is being hotly debated.
Overrepresentation or underrepresentation further widens the North-South divide. However, before arriving at an amicable solution to political equity, India must address another critical issue: Fiscal equity.
The Finance Commission is a constitutional body mandated to recommend the sharing of taxes between the Centre and states. The tenure of the 15th Finance Commission, now in office, will end in 2026.
The President has appointed former Niti Aayog Vice-Chairman Aravind Panagariya as the Chairman of the 16th Finance Commission, which will assume office on 1 April 2026 for a five-year period.
Though the Finance Commission’s recommendations are not binding on the government, they cannot be ignored. They play an important role in shaping Indian fiscal federalism.
Local bodies in India may be the world’s largest democratic institution since they bring
democratic principles to the grassroots and empower millions of women, scheduled castes, and other vulnerable communities. This form of governance has become more participative.
According to a Reserve Bank of India report, local bodies generate only 30% of their expenses. Struggling to generate their revenues, they heavily depend on state government transfers and other forms of grants.
Empowering local bodies has far-reaching benefits as it will allow the elected representatives to address local issues.
During his visit to Kerala, Panagariya lauded the performance of its local self-government bodies.
The Devolution Index (DI) of panchayats (2024) indicates that Karnataka, Kerala, and Tamil Nadu are in the lead positions.
However, according to the 15th Finance Commission, the three leading states received ₹59,957 crore of the total ₹10,57,911 crore grant — including health grants — to local bodies. This is only 5.67% of the total grant.
Meanwhile, Rajasthan, Uttar Pradesh, and Maharashtra together received 13% of the total grant. Despite the excellent performance, this discrepancy in the distribution of local body grants needs to be fixed.
In countries like Germany and Sweden, local governments are guaranteed direct tax-sharing arrangements to run their operations. Such an arrangement is necessary in India to avoid “punishing” the lead performers.
India must also recognise the population differentials between states. The southern states that have successfully implemented the family planning programmes, now face the twin problem of a declining replacement ratio and an aging population.
Based on the Elderly in India 2021 report, the share of the elderly population in Kerala, Tamil Nadu, and Karnataka are 16.5%, 13.6%, and 11.5%, respectively, against Rajasthan’s 8.6%, Uttar Pradesh’s 8.1%, and Bihar’s 7.7%.
The population shift is anticipated to increase by 2031. The projected geriatric population is 20.9% in Kerala, 18.2% in Tamil Nadu, and 15.0% in Karnataka, whereas it will be 11.2% in Rajasthan, 10.3% in Uttar Pradesh, and 9.5% in Bihar.
These figures underscore the need for state-level intervention and appropriate fiscal provisions to address the aging population, the most vulnerable and in need of sustained health and economic support.
The Finance Commission must recognise that population indicators are not one-size-fits-all. The aging population requires significantly more fiscal support than the working population groups.
To rectify this imbalance, the Finance Commission should establish a special aging population fund.
The aging states need support in the form of allocation. Japan and South Korea adjust their
national transfers based on elderly dependency ratios. India should implement a similar scheme to achieve a fair distribution of resources so that states with an aging population will not be disadvantaged economically.
Though the 14th Finance Commission increased the states’ share of central taxes to 42% from 36% in 2017, the actual proportion of money was not assigned to the states.
The funds were bypassed, citing cess and surcharges, and the divisible pool declined over the years. For every 100 rupee, cess constitutes almost ₹10-11 which reached its peak during 2021-22 to at ₹13.5.
The increase in cess and surcharge has been adversely limiting the states’ revenue by reducing the divisible pool. Leaders in many non-BJP-ruled states have voiced their displeasure over the increasing cess. They demanded the Centre abolish the cess tax and bring everything under the divisible pool as it allows more tax diversion to states.
The Economic Survey 2024-25 indicates that the Center’s non-shareable tax revenue has increased over time, due to a growing reliance on cess and surcharges that are not shared with the states. The SR Bommai versus the Union of India case (1994) affirmed that states are equal partners. Excessive central taxation violates fiscal federalism.
The Constitution of India states that “India, that is Bharat, is a Union of States” and recognises states as important partners in governance.
It entrusts various day-to-day administration to state governments so that they can give policy responses to local needs and conditions.
States, however, do not have an appropriate share of fiscal resources, which dilutes their capability to give effective delivery of public services. A more equitable distribution of
funds are needed to promote federalism and increase the government’s performance.
The Prime Minister’s Economic Advisory Council’s report on the relative performance of states
highlights the pivotal role of the state governments as drivers of development and growth. The report identifies how economic performance varies mainly due to the differing quality of government and policy implementation between states.
States must be fiscally enabled to unlock the full potential of the demographic advantage of India and attain sustainable, inclusive development.
Tamil Nadu Chief Minister MK Stalin and Kerala Chief Minister Pinarayi Vijayan have demanded the Centre to increase the states’ share divisible pool of taxes to 50%.
More than 20 states have also asked for the increase, arguing that more funds are necessary to address existing issues, develop infrastructure, and build social capital for the future.
It may be noted that states currently spend over 60% of public expenditure on health, education, and infrastructure but only retain 41% of the tax collections.
Internationally, the United States, among others, follows a virtually equal revenue-sharing arrangement between the federal government and the state governments. India could follow such an arrangement to achieve fiscal balance.
At least, the Finance Commission should conduct a study into the practicability of a 50:50 revenue-sharing arrangement to uphold the federal character and enable the effective discharge of the expanding responsibilities of the states.
Finance Commissions have traditionally tried to formulate policy proposals to maintain intra-generational balance among the states. Today, however, matters are more complex as the population trends have dramatically altered.
For instance, the southern states now bear a disproportionate share of the aging population with one-fifth of their population in the above 60 age group. Such a situation requires a re-evaluation of the existing fiscal frameworks, with the distribution of resources being adjusted to the new
population realities and pressing socio-economic concerns.
Besides the simple allocation of funds among states in various forms, the Finance Commission must have a more active function to promote Indian federalism. The commission must recognise states as partners in the process of governance and allocate resources equitably to enable the states to effectively respond to regional needs.
Inclusive development in all regions and sections of society is a condition of the Viksit Bharat vision. If the development process is not inclusive, the middle-income trap is waiting,
as economists have already warned.
To address this issue, the states’ important position in the system of government should be recognised and entrusted with their due share of resources. Fiscal policy needs to be formulated with a multi-pronged approach that ensures intragenerational and intergenerational equity in the distribution of resources.
Strengthening state-level capacities alone will enable India to unlock its full potential and
attain sustainable, inclusive economic development.
(Abhijay A is a policy analyst and columnist. Thirunavukarasu S is a Junior Research Fellow at the University of Madras. Views expressed are those of the authors. Edited by Majnu Babu).
