Inter-State Variations in Central Tax Distribution

• 18 Mar 2023

For Prelims: 15^th Finance Commission, Central Tax Distribution, Horizontal equity, Article 280 of the Constitution.

For Mains: Taxes Distribution Among States, Recommendations of 15th Finance Commission.

Why in News?

Critics argue that the 15^th Finance Commission formula is skewed in favour of some states, resulting in wide inter-state variations.

• Tamil Nadu gets back only 29 paise for every one rupee it gives to the Centre, while Uttar Pradesh gets ₹2.73 and Bihar gets back ₹7.06.

How Taxes are Distributed Among States?

• About:
  • The Centre collects taxes from states and distributes it among them based on the Finance Commission's (XVFC) formula.
• XVFC Formula:
  • The XVFC formula is based on each state's needs (population, area and forest and ecology), equity (per capita income difference), and performance (own tax revenue and lower fertility rate).
• Weightage:
  • Needs are given 40% weightage, equity 45%, and performance 15%.
  • The XVFC introduced the fertility rate component to reward states that have reduced fertility levels, but this has a lower weightage than equity and needs.
• Arguments:
  • Critics argue that this formula favours some northern states, as the population is given higher weightage.
    • The southern states' share has consistently declined in successive Finance Commissions.
  • Some argue that transfers enable a state to provide comparable levels of services and ensure horizontal equity.
    • However, others contend that the formula should not adversely impact a state's efficiency and progress.

What is the 15^th Finance Commission?

• About:
  • The Finance Commission (FC) is a constitutional body that determines the method and formula for distributing the tax proceeds between the Centre and states, and among the states as per the constitutional arrangement and present requirements.
• Constitutionality:
  • Under Article 280 of the Constitution, the President of India is required to constitute a Finance Commission at an interval of five years or earlier.
• 15^th Finance Commission
  • The 15^th Finance Commission was constituted by the President of India in November 2017, under the chairmanship of NK Singh.
  • Its recommendations will cover a period of five years from the year 2021-22 to 2025-26.
    • The government accepted the 15^th Finance Commission’s recommendation to maintain the States’ share in the divisible pool of taxes to 41% for the five-year period starting 2021-22.

UPSC Civil Services Examination, Previous Year Question (PYQ)

Q. How have the recommendations of the 14th Finance Commission of India enabled the States to improve their fiscal position? (2021)

Source: TH