Relevance: GS Paper III (Economy)
Theme of the Article
The time has come to amend the Constitution to fix the proportion of shareable taxes for the States.
Introduction
It is well known that the efficiency of a government depends on, among other factors, its structure. In large countries, it has been felt that only a federal structure can efficiently meet the requirements of people from different regions.
Fiscal federalism
- Fiscal federalism is the economic counterpart to political federalism. Fiscal federalism is concerned with the assignment on the one hand of functions to different levels of government, and with appropriate fiscal instruments for carrying out these functions on the other.
- It is generally believed that the Central government must provide national public goods that render services to the entire population.
- An important question in fiscal federalism is the determination of the specific fiscal instruments that would enable the different levels of government to carry out their functions. This is the ‘tax-assignment problem’.
Mobile and Benefit Taxes
- It is generally argued that the de-centralised levels of government should avoid non-benefit taxes and taxes on mobile units. This implies that the Central government should have the responsibility to levy non-benefit taxes and taxes on mobile units or resources.
- Building these principles into an actual scheme of assignment of taxes to different levels of government in a Constitution is indeed very difficult. Different Constitutions interpret differently what is mobile and what is purely a benefit tax.
- For example, in the United States and Canada, both Federal and State governments have concurrent powers to levy income tax. On the contrary, in India, income tax is levied only by the Central government though shared with the States.
Taxation in Indian Constitution
- The Indian Constitution lays down the functions as well as taxing powers of the Centre and States.
- The issues relating to the correction of vertical and horizontal imbalances have been addressed by every Finance Commission.
- However, Central transfers to States are not confined to the recommendations of the Finance Commissions. There are other channels such as those through the Planning Commission until recently as well the discretionary grants of the Central government.
Trends in Distribution of Tax Receipts
- In 2010-11, in the combined revenue receipts of the Centre and States, the share of the Centre was 64.68%. After transfer, the share came down to 40.20%.
- In the case of the States, their share before transfers was 35.32%. After the receipts of transfers the share of States went up to 59.80%. Thus the shares got reversed.
- In 2016-17, the share of the Centre after transfers was 33.37% and that of the States was 66.63%. In the case of total expenditures, the share of the Centre in 2014-15 was 41.14% and that of the States was 58.86%.
New Developments
- The Fourteenth Finance Commission has broken new ground in terms of allocation of resources.
- One of its major recommendations has been to increase the share of tax devolution to 42% of the divisible pool. This is a substantial increase by almost 10 percentage points.
- The commission has argued that this does not necessarily affect the overall transfers but only enhances the share of unconditional transfers.
The Encroachment by Centre
- It is true that Centrally sponsored schemes, which have ballooned in recent years, may have ‘encroached’ on the territory of States.
- Today, the Central government is held responsible for everything that happens, including, for example, agrarian distress. In viewing the responsibilities of the Centre and States we must take a broader view than what is stipulated in the Constitution.
Unconditional Transfers
On the allocation of unconditional transfers, two questions arise.
- The first is to determine the total transfers that need to be made, while the second is whether all transfers must be done by the Finance Commission alone.
- The Planning Commission was replaced by the NITI Aayog, which was simply a think-tank with no powers of resource allocation. In this context perhaps what the Fourteenth Finance Commission did was justifiable.
Way Forward
- Perhaps the time has come for the Constitution to be amended and the proportion of shareable taxes that should go to the States fixed at the desired level.
- The shareable tax pool must also include cesses and surcharges as these have sharply increased in recent years. Fixing the ratio at 42% of shareable taxes, including cesses and surcharges, seems appropriate.
- Another possible route is to follow the practice in the U.S. and Canada: of allowing the States to levy tax on personal income, with some limitations. Since one of the concerns is that resources do not match functions, this may be a way out.
- The levy by the Centre and States together should be reasonable. Also once this power is given to the States, the transfers from the Centre need adjustment. As far as India is concerned, this is an area which needs a fuller study. Adoption of any one of these alternatives will avoid friction between the Centre and the States.
- The ability of bringing about equalisation across States in India has limitations. The relatively richer States have feel ‘cheated’ because of the overuse of the equity criterion. An appropriate balancing of criteria is needed.
