Recent data presented in Parliament (2020-21 to 2024-25) highlights a structural asymmetry in Indian fiscal federalism: a significant divergence exists between a State’s tax contribution to the Centre and its share in the divisible pool of taxes.
The Constitutional Mechanism: Article 280
The distribution of financial resources in India is not arbitrary but governed by the Finance Commission (FC), a constitutional body constituted every five years under Article 280.
- Vertical Devolution: Determines how much of the Net Tax Proceeds the Centre shares with the States in aggregate (currently 41% as per the 15th FC).
- Horizontal Devolution: Determines how that 41% is distributed among the 28 states. This mechanism causes the disparity between “contribution” and “receipt.”
ThEquity vs. Efficiency
The variation in tax returns is intentional, designed to uphold the principle of Equity (balanced regional development) over Efficiency (rewarding revenue generation).
1. The “Income Distance” Factor
- Definition: It measures how far a state’s Per Capita Income is from the state with the highest Per Capita Income (proxy: Haryana).
- Impact: This criterion holds the highest weight (45% in the 15th FC).
- Outcome: States with lower per capita income (Bihar, UP) are awarded a higher share to bridge the development gap. Consequently, states with high per capita income (Maharashtra, Tamil Nadu) see their share reduced, regardless of their high tax contribution.
2. Demographic Performance
- To balance the needs of populous states with the efforts of states that controlled population, the 15th FC introduced “Demographic Performance” (12.5% weight) to reward states with lower fertility rates, offsetting the “Population” criteria (15% weight).
Population (15% Weight): Based on 2011 Census data.
- Tax Effort (2.5% Weight): Rewards states with better tax collection efficiency.
Cesses and Surcharges
A critical concept impacting the actual flow of funds is the composition of the Divisible Pool.
- Exclusion: Under Article 270 and 271, revenues collected through Cesses (e.g., Agriculture Infrastructure Cess) and Surcharges are exclusive to the Centre.
- Implication: Even if tax collections rise, if the increase is driven by cesses/surcharges, the states’ share does not increase proportionately, affecting their fiscal health.
