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States Demand Larger Share in Divisible Tax Pool

Syllabus:

GS-2:

Centre-State Relations

GS-3:

Fiscal Policy , Government Budgeting

Focus:

Several states have urged the 16th Finance Commission to increase their share of the divisible tax pool, citing concerns over shrinking allocations due to cesses and surcharges. This demand raises critical issues of fiscal autonomy, inter-state inequality, and governance reforms at the state and local levels.

Background and Context

• State Demands for Increased Share in the Divisible Tax Pool
  

  • Several states have presented their demand to the 16th Finance Commission for a higher share in the divisible tax pool, proposing an increase from the current 41% to 50%.
  • States argue that they have a legitimate grievance due to the reduction in the share of tax revenues allocated to them by the Centre in recent years.
  • The 14th Finance Commission had raised the states’ share to 42%, but the 15th Finance Commission reduced it to 41%, primarily due to the reorganization of Jammu & Kashmir as a Union Territory.
• Declining Tax Pool Allocation
  
  • One key issue is that the Centre has reduced the divisible tax pool by imposing cess and surcharges, revenue from which is not shared with states.
  • In 2021-22, the divisible tax pool accounted for only 9% of the Centre’s gross tax revenues, down from 88.6% in 2011-12.
  • Over the past six years, states have received only 32% of gross tax revenues, leading to a significant reduction in their fiscal space.

Fiscal Challenges and Centre’s Budget Constraints:

• Implications for Centre’s Fiscal Space
  

  • Given the demands on the Centre’s budget, increasing overall transfers to states could place a strain on national finances.
  • States currently account for around 60% of general government expenditure, which puts additional pressure on the fiscal resources available to the Centre.
  • While states seek greater fiscal autonomy, achieving this will require the Centre to rework the composition of transfers, focusing more on untied funds rather than tied transfers.
• Rationalizing Centrally-Sponsored Schemes
  
  • To accommodate higher untied transfers, the Centre would need to rationalize centrally-sponsored schemes, which are politically motivated and often involve expenditure on matters within the states’ jurisdiction.
  • Successive governments have, through these schemes, increased spending on items falling under the state and concurrent lists, despite grants to states exceeding the Centre’s revenue deficit.
  • This has led to an unsustainable borrowing trend to fund transfers, raising concerns over fiscal responsibility.

Fiscal Autonomy vs. Quality of Spending:

• Concerns Over Revenue Deficits in States
  

  • Many states are already facing worsening revenue balances, which implies they are borrowing to cover daily operational expenses, such as interest payments and subsidies.
  • Even states like Karnataka, traditionally fiscally strong, have slipped into a revenue deficit, which affects their capacity to increase capital spending from their own resources.
  • Higher untied transfers could potentially provide more fiscal space, but the risk is that they might lead to increased spending on non-merit subsidies, such as subsidies for power and water, rather than productive investments.
• Cash Transfer Schemes and Fiscal Diversion
  
  • A significant rise in cash transfer schemes across various states raises concerns about the diversion of financial resources away from productive investments.
  • According to a report from Axis Bank, 14 states have announced income transfer schemes, which account for about 6% of the country’s GDP.
  • These schemes, funded by borrowing and expenditure switching, have become politically attractive, but they raise doubts about whether untied transfers will primarily fund such initiatives, thus weakening fiscal discipline.

Equity and Efficiency Concerns:

• Impact on State Inequality
  
  • One of the core concerns in rebalancing the composition of tied and untied transfers is the issue of equity. States like Bihar, which have relatively low income levels, are likely to benefit less from an increase in untied transfers.
  • Higher-income states that already spend more on public services might see a disproportionate share of untied funds, exacerbating the growing regional inequalities.
  • Therefore, a larger share of untied transfers could potentially undermine efforts to address inter-state disparities in public service delivery.
• Quality of Public Service Delivery
  
  • The equitable delivery of public services across the country remains a challenge, and increasing untied transfers without addressing state-level governance and administrative inefficiencies could further entrench existing disparities.
  • The Finance Commission must ensure that any rebalancing of transfers between the Centre and the states is aligned with the goal of improving the quality of public services for citizens, especially in poorer states.

Strengthening the Third Tier of Government:

• Fiscal Devolution to Local Bodies
  
  • An increase in untied transfers raises important questions about the role of the third tier of government (panchayats and municipalities) in India’s federal structure.
  • In comparison to other countries like China and South Africa, the share of government spending allocated to local bodies in India remains comparatively low.
  • States themselves often restrict devolution of resources and functions to local governments, which diminishes the ability of the third tier to carry out essential services.
  • The Finance Commission needs to assess whether increased untied transfers could incentivize states to enhance devolution to the third tier, thereby strengthening local governance.
• Improving State and Local Governance
  
  • To maximize the potential benefits of increased untied transfers, state governments must be held accountable for the effective use of these funds.
  • This may require a reassessment of governance structures and financial management practices at both the state and local levels to ensure that increased fiscal autonomy translates into improved public service delivery.
• Challenges:
• Regulatory Clarity
• Ambiguity over categorization of genome editing vs. GMOs may hinder adoption.
• Varying international regulations can affect exports.
• Public Perception and Acceptance:
• Misinformation and fear surrounding gene-editing may lead to resistance from farmers and consumers.
• Infrastructure and Training:
• Farmers need access to proper training and awareness about cultivation practices of new varieties.
• Extension services may be inadequate in remote areas.
• Environmental Concerns:
• Long-term ecological impacts are still under study, particularly gene flow to wild relatives.
• Biodiversity concerns in mono-cropping regions.
• Equitable Access:
• Small and marginal farmers might struggle to access seeds or reap full benefits without support.

Way Forward:

• Robust Policy Framework:
• Establish a clear regulatory distinction for genome editing from GM crops.
• Streamline approval processes based on scientific risk assessment.
• Awareness and Education:
• Launch targeted campaigns to educate farmers and the public on safety and benefits.
• Promote genome editing literacy through agri-extension networks.
• Infrastructure Support
• Strengthen supply chains, cold storage, and irrigation tailored to the new varieties.
• Facilitate access to seeds through public-private partnerships.
• Research and Monitoring:
• Continue long-term studies on environmental impact and crop performance.
• Monitor adoption patterns and ensure feedback integration for future improvements.
• International Engagement:
• Work with global bodies to harmonize standards for genome-edited crops to avoid trade barriers.

Conclusion:

• The 16th Finance Commission faces a difficult task in balancing the demands for increased fiscal transfers to states with the need to maintain fiscal discipline at the Centre. While states’ calls for greater autonomy and a larger share in the divisible tax pool are valid, they must be weighed against concerns regarding the quality of spending, regional inequality, and the fiscal health of both states and the Centre. Additionally, any changes in transfer mechanisms must be accompanied by reforms to strengthen local governance and ensure that resources are used effectively and equitably.

Source: IE

Mains Practice Question:

Discuss the implications of states’ demand for an increased share in the divisible tax pool. How can the 16th Finance Commission balance the fiscal autonomy of states with the fiscal constraints of the Centre while ensuring equitable public service delivery across states?