• UGI USER
  • Jan 23, 2024
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TAX CONTRIBUTION BY STATES NEEDS TO BE REVISITED

Relevance:

GS 2

  • Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.
  • Inclusive growth and issues arising from it.

Why in News:

The 16th Finance Commission has an opportunity to break new ground by incorporating GST and petroleum consumption as metrics for States’ tax contributions.

Source- NITI AAYOG

The Finance Commission plays a pivotal role in recommending a distribution formula for allocating Union tax revenue to states. Over time, this formula has evolved with various weighted determinants. This article emphasizes the need to reevaluate the concept of tax contributions by states and argues for its inclusion in the distribution formula, especially in light of the Goods and Services Tax (GST) regime.

Equity and Efficiency in Tax Revenue Transfers

Historical Background

  • Since the inception of the 1st Finance Commission, states have debated the fairness of their contributions to Union tax revenue.
  • In the early Finance Commissions (up to the 8th), tax contribution had minimal influence on the distribution formula.
  • From the 10th Finance Commission onward, tax contribution was excluded from the formula.

Importance of Tax Contribution

  • Tax contribution by each state serves as an efficiency indicator.
  • It reflects a state’s development level and economic structure.
  • Despite its significance, it has historically received limited weight (10%-20%) in distribution formulas.

Equity and Efficiency in Tax Revenue Allocation

Finance Commissions have two primary tasks:

  • Recommending the proportion of Union tax revenues allocated to states.
  • Determining the share of each state in this allocated revenue.
  • Prior to the 10th Finance Commission, states received shares primarily from personal income tax and Union excise duties.
  • The distribution formula seeks to strike a balance between equity and efficiency.
  • Equity aims to allocate more to revenue-scarce states and those with higher expenditures.
  • Efficiency rewards states proficient in revenue collection and spending rationalization.
  • The weightage assigned to equity indicators has consistently been higher than efficiency indicators, with more than 75% allocated to equity in recent Commissions.

Incorporating Tax Contribution in the Formula

Challenges with Previous Indicators

  • States have proposed higher weightage for ‘tax collection’ as an indicator, but it posed challenges due to the origin of income.
  • Income tax collection/assessment received limited weight (10%-20%) due to its inadequacy as an indicator.
  • In the case of Union excise duties, the lack of accurate consumption statistics made it an unsuitable determinant.

The GST Opportunity

  • The introduction of GST offers an opportunity to incorporate tax contribution into the distribution formula.
  • GST is a unified, consumption-based destination tax divided equally between states and the Central government.
  • It enables precise estimation of each state’s tax contribution to the Union exchequer.
  • Under GST, variations in tax efforts among states are minimal, but the absolute amount of GST revenue varies based on states’ economies.

Petroleum Consumption as an Indicator

  • Petroleum consumption is another indicator reflecting tax contribution to the national exchequer.
  • Union excise duty and sales tax on petroleum products fall outside GST.
  • The relative shares of petroleum consumption remain stable over time for each state.

Recommendations for the 16th Finance Commission

Incorporating Efficiency Indicators

  • Efficiency indicators like tax effort and fiscal discipline have received lower weights due to their instability.
  • Tax effort is influenced by discretionary tax policies and unexpected changes in tax bases.
  • Fiscal discipline is affected by contractual payments and tied-grant-induced expenditures.
  • Objective measures of tax contribution by states, reflecting the stability in tax structure, should be given greater weight.

Inclusion of GST and Petroleum Consumption

  • GST revenue and petroleum consumption are fair and accurate measures of states’ contributions to the national exchequer and indicators of efficiency.
  • The 16th Finance Commission should consider incorporating these ratios into the distribution formula with a suggested weightage of at least 33%.

Reevaluating tax contributions by states is essential for promoting efficiency and equity in the distribution formula for Union tax revenues allocated to states. Leveraging the GST regime and considering factors like petroleum consumption can enhance the fairness and accuracy of this allocation process.

Finance Commission Overview

·   The Finance Commission is a constitutionally mandated body central to fiscal federalism.

·   Established under Article 280 of the Constitution to recommend the division of tax revenue between the Union and states and among states.

·   The President is empowered to constitute a Finance Commission every 5 years, starting five years after the Constitution’s commencement.

·   The Commission comprises a Chairman and 4 other members, with qualifications and procedures determined by Parliament.

·   Draft Article 260 initially defined the Commission’s duties.

Amendment to Article 280 (1992)

·   In 1992, Article 280 was amended to broaden the Finance Commission’s role.

·   It now includes making recommendations to the President on increasing funds in a State’s Consolidated Fund to support Panchayats and Municipalities, based on State Finance Commission recommendations.

 

Source

The Hindu

Mains Question

Discuss the major economic reforms that have shaped India’s economic landscape since the early 1990s. Evaluate their impact on various sectors and the overall socio-economic development of the country.