Context

• The centralisation of fiscal powers in India has been blamed for the poor fiscal health of the states.

Why in news?

• Chief Ministers expressed their concern about dwindling State revenues in a NITI Aayog meeting chaired by the Prime Minister.
• They sought a higher share in the divisible pool of taxes and an extension of GST compensation, both of which have long remained a bone of contention between the Union government and the States.

Need for financial devolution

• To strengthen democracy at grass root level with more revenue resources for better service delivery.
• To increase accountability to people so performance can be realized as direct contact with people.

What is divisible pool of taxes?

• The divisible pool is that portion of gross tax revenue which is distributed between the Centre and the States. The divisible pool consists of all taxes, except surcharges and cess levied for specific purpose, net of collection charges.

What is fiscal federalism?

• Fiscal federalism refers to how federal, state, and local governments share funding and administrative responsibilities within our federal system. The funding for these programs comes from taxes and fees.

Poor state of state finances

• Stagnant revenue: Since States cannot raise tax revenue because of curtailed indirect tax rights — subsumed in GST, except for petroleum products, electricity and alcohol — the revenue has been stagnant at 6% of GDP in the past decade.
• Distorted expenditure: While States lost their capacity to generate revenue by surrendering their rights in the wake of the Goods and Services Tax (GST) regime, their expenditure pattern too was distorted by the Union’s intrusion, particularly through its centrally sponsored schemes.
• Decline in share: The ability of States to finance current expenditures from their own revenues has declined from 69% in 1955-56 to less than 38% in 2019-20.
• Stress on finance: States’ financial health had taken a turn for the worse with the implementation of the Ujwal DISCOM Assurance Yojana, farm loan waivers, as also the slowdown in growth in 2019- 20.

Key fact to remember

Finance Commission keeps tax devolution for states at 41% in FY22

How fiscal centralisation impacts on states?

• Cut in the corporate tax: The recent drastic cut in corporate tax, with its adverse impact on the divisible pool, and ending GST compensation to States have had huge consequences.
• States paying high interest rates: States are forced to pay differential interest — about 10% against 7% — by the Union for market borrowings.
• Centrally sponsored schemes curbing autonomy: There are 131 centrally sponsored schemes, with a few dozen of them accounting for 90% of the allocation, and States required to share a part of the cost.

 Suggestions for strong fiscal federalism

• Creation of federal institution: We need to create another institution in the form of a GST state secretariat that can bring together senior officers from the Centre and states in an institutional forum registered under the Society Act.
• State Finance Commissions: should be accorded the same status as the Union Finance Commission and the 3Fs of democratic decentralization (funds, functions, and functionaries) should be implemented properly.
• Robust GST regime: Transparency, simplification and rationalisation of GST will help states to recover soon.

Way Forward

• Relook on various exemptions to rationalise the taxes/levies
• Augmentation of Tax Administration Structure
• Technology-based Tax Administration may also be further expanded to cover even utility charges like water, street lights, sanitation charges, etc.

Conclusion

• It is important now to rethink the design and structure of a genuine fiscal partnership, which should not merely be a race to garner more resources, but a creative attempt to move towards a vibrant Indian value chain that can catapult India’s growth rate closer to the quest for double-digit growth.

Mains question

Q. Why it is important now to rethink the design and structure of a genuine fiscal partnership? Discuss this in context of Skewed divisible pool and state of fiscal federalism in India.

 

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