Just when the states need more freedom and flexibility in financial management, the tendency has been to promote the over-centralisation of powers.
Published Sep 10, 2024 | 1:00 PM ⚊ Updated Nov 26, 2024 | 2:51 PM
Image of the iconic Charminar in Telangana's Hyderabad (Wikimedia Commons)
Federalism is the bedrock of our constitution. It is only by ensuring fiscal fairness, and equality and protecting the rights of the states that the spirit of federalism can be sustained. Unfortunately, over the last decade, there has been a systematic attempt to chip away at the core principles of fiscal federalism, weakening the states.
At a time when States need more freedom and flexibility in matters of financial management, the tendency has been to promote the over-centralisation of powers. As a result of such a skewed model, progressive and performing states feel that they have been short-changed in terms of the devolutions.
The fiscal journey of Telangana, India’s youngest state, bears testimony to this. At the time of its formation, Telangana was up against a plethora of hurdles. However, the welfare and development initiatives ensured that the state’s economy consistently grew at an average annual rate of more than 9 percent.
But what did the state get in return? Ironically, a raw deal from the Centre. Despite contributing a lion’s share to the country’s economy, Telangana suffered discrimination in the allocation of funds and a sharp cut in the share in the Central taxes, while the promises made as part of the Andhra Pradesh Reorganisation Act remain unfulfilled.
The declining share of states in real terms in the divisible pool of taxes, faulty implementation of the Goods and Services Tax (GST) regime and restrictions on borrowings by the states are some of the issues that have created tensions in relations between the Centre and states.
There is an urgent need for increasing the states’ share in central pool of taxes from the present 41 percent to 50 percent. Though the 15th Finance Commission recommended that 41 percent of central taxes be devolved to states, the actual amount the states are receiving is only about 30 percent. This is because the Centre has been relying more on cesses and surcharges, which do not need to be shared with states.
Though the successive Finance Commissions have been recommending cutting down the share of cesses and surcharges, the Centre has been simply side-stepping this recommendation. At the time of framing the Constitution, non-tax revenues were insignificant and therefore not included in the divisible pool. But over the years, non-tax revenues of the Centre have become more buoyant.
Non-tax revenues, which are not shared with States, have increased from a mere ₹175 crore in 1960-61, to ₹2.85 lakh crore in 2022-23. An amount of ₹5.46 lakh crore is budgeted in 2024-25. Therefore, there is a strong case for the inclusion of non-tax revenues in the divisible pool.
Over the years, the states with lower per capita incomes have been getting higher tax devolution. While there is a need to address both equity and efficiency, excessive focus on equity parameters has not served the purpose of reducing income inequalities across states. On the contrary, income inequalities have been widening.
The problems of backward States can be better addressed by increasing the absorptive capacity and providing funds for infrastructure development. For this, a separate non-lapsable Infrastructure Fund for Backward States outside the dispensation of the Finance Commission is a better option.
At present, the Centre is collecting ₹1.40 lakh crore from surcharges on income and corporation taxes, which are not purpose-specific and form part of the Consolidated Fund of India. This amount can fund the proposed Infrastructure Fund. This will facilitate the growth of backward States without disincentivising performing States.
There is a need to incentivise States which have improved their tax collections and their base and to encourage others to follow suit. Tax revenues are the most important source of own revenues of States and constitute over 80 percent of their own revenue receipts. There is a need to increase the weightage assigned to tax effort in the devolution formula to 10 percent from the previous 2.5% percent.
The imminent delimitation of constituencies in 2026 will result in a paradoxical situation where the states which have put in better demographic performance will stand to lose in terms of representation. In fact, their share in tax devolution has been coming down with each successive Finance Commission because of higher weightage to distance of per capita income from the highest per capita income State.
This is a double whammy for states like Telangana where the state’s share in tax devolution has come down from 2.437 percent in 2014-15 to 2.133 percent in the award period of the 14th Finance Commission and further to 2.102 percent in the award period of 15th Finance Commission.
In the present system, there are several inherent imbalances in the revenue resources and responsibilities assigned to the Centre and the states. While the Centre is assigned with more sources of revenue with nation-wide base, the states are assigned with more responsibilities in impacting people’s lives.
If the Centre is serious about preserving and strengthening fiscal federalism, it needs to rebuild the trust of the states. The 16th Finance Commission must objectively determine the tax devolution criteria with an objective of reducing the inter-state disparities.
(T Harish Rao is a BRS MLA from Telangana and former minister for legislative affairs. Views are personal. Edited by Neena)
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