Centre-State Revenue Dynamics | 18 Jan 2025

Source: TH 

Why in News?

In the past decade (Fiscal Year 2016 (FY16) to FY25), the share of States' revenue derived from Central transfers and grants has significantly increased, highlighting a growing dependence on the Centre.  

• A significant rise in the Centre’s share of state revenue, coupled with declining efficiency in states' tax collection efforts, has deepened this reliance.  

What are the Key Trends in States’ Revenue Composition? 

• Pandemic Aftermath: States’ revenue expenditures increased by 14% during the Covid pandemic due to welfare measures. 
  • Capital expenditure for infrastructure slowed, affecting long-term economic growth. 
• Debt-to-GDP Ratio Trends: While states' debt-to-GDP ratio (relative measure of debt compared to economic output) is at 28.5% in March 2024. This indicates that states' fiscal health is still under strain. 
  • State debt levels exceed the Fiscal Responsibility and Budget Management committee's recommended debt-to-GDP ratio of 20% for states, highlighting the unsustainable debt burden faced by states. 
• Increased Central Transfers: States' revenue from Central transfers has increased to 23-30% of their total revenue in the last decade, compared to 20-24% in the 2000s and early 2010s. 
  • Grants from the Centre now account for 65-70% of States' non-tax revenue, up from 55-60% earlier. 
• States' Own Tax Revenue: It has consistently remained below the 50% mark as a share of total revenue over the last decade, whereas it often exceeded 50% in the 2000s. 
  • Despite State Goods and Services Tax (SGST) contribution increasing from 15% to 22% of States' total revenue between FY18 and FY25, the share of own tax revenue (excluding SGST) has fallen from 34% to 28%. 
• Reduced Non-Tax Revenue: The share of non-tax revenue in total revenue is projected to fall below 24% in FY25, the lowest in 25 years. 
  • Key components like interest receipts and dividends from State public sector enterprises remain negligible (under 1%). 
  • Earnings from services rendered, such as public health (social service) and power (economic service), did not cross the 30% mark in the last decade. 
• Inefficiency in Tax Collection: Revenue from avenues like stamp duty, registration fees, and motor vehicle taxes has been insufficient due to sporadic and inefficient collection efforts. 
  • The own tax revenue to Gross State Domestic Product (GSDP) ratio has declined in major States like Tamil Nadu, Kerala, and Karnataka, indicating a systemic issue in tax mobilisation. 

What are the Implications of Increasing Dependency of States on Centre? 

• Fiscal Autonomy at Risk: States often depend heavily on the Centre for funding due to the uneven distribution of revenue-raising powers.  
  • The Centre controls dynamic taxes like income tax and GST, while states manage slower-growing taxes such as sales tax and land revenue.  
  • This imbalance restricts states' fiscal independence, limiting their capacity to tailor policies to local needs.  
  • Additionally, tax decisions like SGST rates are influenced by the GST Council, where states have limited bargaining power, further constraining their autonomy. 
• Constraints on Developmental Expenditure: Weaker fiscal states often face inadequate resources as central allocations may prioritize performance over need, deepening inter-state inequalities and widening regional disparities.  
  • Inefficient tax mobilization hampers states' ability to meet rising developmental demands.  
  • Heavy dependence on the Centre also limits states' capacity for counter-cyclical fiscal measures, crucial for stimulating aggregate demand. 
• Political Tensions: Centralised decision-making in tax policies led to disagreements between the Centre and Opposition-ruled States. 
• Overburdened Central Government: States' increasing dependence on the Centre could strain the nation's overall fiscal health, limiting the Centre's ability to support states during economic downturns or crises. 

How Can States Improve Revenue Mobilisation? 

• Strengthen Fiscal Federalism: Increase states’ share in revenue through progressive recommendations by the Finance Commissions, as seen in the 14th and 15th Finance Commissions, which raised the tax devolution share to 42% and 41% respectively. 
• Enhancing Tax Collection Efficiency: Implement technology-driven solutions to improve collection from property taxes, motor vehicle taxes, and registration fees. 
  • Modernising tax administration systems to reduce evasion and enhance compliance. 
  • Incentivize states to improve their tax collection mechanisms and fiscal discipline through performance-based grants. 
• Broadening the Tax Base: Explore new revenue sources, such as environmental taxes or congestion charges, tailored to State-specific contexts. Rationalise tax exemptions and subsidies to maximise revenue. 
• Strengthening Non-Tax Revenue Sources: Boost earnings from State public sector enterprises by improving operational efficiency. Monetise underutilised State assets and services. 
• Collaborative Policy Making: Increase engagement with the GST Council to advocate for region-specific needs. Work towards harmonising tax policies across States to reduce disparities. 
  • Foster inter-State knowledge sharing to replicate best practices. 
• Leverage Central Schemes: Utilize programs like Gati Shakti and capital assistance schemes to spur economic activity and support infrastructure development. 
• Reduce Public Debt: Tighten fiscal discipline with data-driven decision-making and prioritize reliance on own-source revenues (SOR). 

Conclusion 

The growing dependence of states on the Centre has led to challenges in fiscal autonomy and development. Strengthening revenue mobilization through improved tax collection and fiscal discipline is essential. Collaborative efforts between states and the Centre can ensure sustainable growth and reduce regional disparities.