Introduction

Several Opposition-ruled states, particularly from southern India, have voiced concerns over the present scheme of financial devolution, citing disparities in the allocation of tax revenue compared to their contributions.
Understanding the concept of the divisible pool of taxes and the role of the Finance Commission (FC) is crucial in addressing these issues.

Divisible Pool of Taxes: Overview

Constitutional Provision: Article 270 of the Constitution outlines the distribution of net tax proceeds between the Centre and the States.
Share of taxes: Taxes shared include corporation tax, personal income tax, Central GST, and the Centre’s share of Integrated Goods and Services Tax (IGST), among others.
Finance Commission’s Role: Article 280(3) (a) mandates FC, constituted every five years, recommends the division of taxes and grants-in-aid to States based on specific criteria.
XVI FC: It consists of a chairman and members appointed by the President, with the 16th Finance Commission recently constituted under the chairmanship of Arvind Panagariya for the period 2026-31.

Vertical Devolution: States receive a share of 41% from the divisible pool, as per the 15th FC’s recommendation.
Key criteria for horizontal devolution: For horizontal devolution, FC suggested 12.5% weightage to demographic performance, 45% to income, 15% each to population and area, 10% to forest and ecology and 2.5% to tax and fiscal efforts.

Income Distance: Reflects a state’s income relative to the state with the highest per capita income (Haryana), aiming to maintain equity among states.
Population: Based on the 2011 Census, replacing the earlier 1971 Census for determining weightage.
Forest and Ecology: Considers each state’s share of dense forest in the total forest cover.
Demographic Performance: Rewards states for efforts in controlling population growth.
Tax Effort: Rewards states with higher tax collection efficiency.

Exclusion of Cess and Surcharge: Around 23% of the Centre’s gross tax receipts come from cess and surcharge, which are not part of the divisible pool, leading to disparities in revenue sharing.
Variation in State Contributions: Some states receive less than a rupee for every rupee they contribute to Central taxes, indicating disparities in revenue distribution.
Reduced Share for Southern States: Southern states have witnessed a decline in their share of the divisible pool over successive FCs, affecting their fiscal autonomy.

Expansion of Divisible Pool: Including a portion of cess and surcharge in the divisible pool could enhance revenue sharing among states.
Enhanced Weightage for Efficiency: Increasing the weightage for efficiency criteria in horizontal devolution, such as GST contribution, can promote equitable distribution.
Greater State Participation in FC: Establishing a formal mechanism for state participation in the FC’s constitution and functioning, akin to the GST council, can ensure a more inclusive decision-making process.

Addressing issues of financial devolution requires a collaborative approach between the Centre and the States, focusing on equitable distribution and fiscal federalism.
Reforms in revenue-sharing mechanisms, along with enhanced state participation in decision-making bodies like the FC, are essential for promoting balanced development and resource allocation across the country.