NEWS If States directly collect more tax, they will become less dependent on the Central government.
INDIA’S REVENUE DISTRIBUTION SYSTEM
- In India, direct taxes go entirely to the Central government (Direct taxes are income tax and corporate tax).
- The Central government is supposed to distribute 41% of its gross tax revenues (reduced from 42% after the formation of new Union Territories in Jammu and Kashmir) to the State governments.
- State governments get funds from the Central government according to the Finance Commission’s recommendations.
- Meanwhile, the Central government has added cess on various items which adds up to over ₹3.5 lakh crore. This is not shared with the State governments.
- State governments also raise their own funds largely through taxes on liquor, property, road and vehicles.
ISSUE WITH THIS SYSTEM OF DISTRIBUTION
- Usually the Central government does not meet the 41% target. We see various States either petitioning or coming into conflict with the Central government on this issue.
- At an all-India level, the States get 26% of their total revenue from the Central government.
- Some of the so-called poorer States get up to 50% of their total revenue from the Central government, making them even more dependent.
- This gives more economic power to the Central government and allows ruling parties at the Centre to use these funds to their advantage.
- Another issue is regional disparity.
- Maharashtra, Delhi and Karnataka contribute the lion’s share of taxes to the government.
- Uttar Pradesh, which has the largest population in India, contributes only 3.12% but gets over 17% of the revenue distributed by the Central government.
- Revenue distribution is based on complex considerations including population and poverty levels. For e.g. every ₹100 contributed, southern States get about 51% from the Central government, whereas Bihar gets about 200%.
- The population growth rates in the south have come down to near zero, whereas the population in central and north India continues to grow.
- Hence, the cross subsidy from the south to the north will therefore grow. Meanwhile, job seekers and those looking for higher quality education are flocking to the south.
- The political power is concentrated in the north because there are more Lok Sabha seats.
- The number of seats in each State will be revised in 2026 perhaps based on population and other factors, creating apprehension in the southern States that they will be further politically marginalised.
WHAT CAN BE DONE?
- Making the fund allocation fairer is almost impossible because of politics. Hence, we need to look beyond this framework.
- One step could be to provide greater economic power to the States so that they can directly collect more taxes and be less dependent on the Central government.
- This would improve Centre-State relations.
- For poorer States, a period of transition is perhaps required.
- India’s hard-won independence and unity needs to be preserved. Today there are threats from multiple directions.
- A transition to a more federal structure will allow the Centre to focus on external threats instead of internal dissensions.
- Our internal divisions helped invaders from West Asia and the British. Hopefully, we will learn from our history.