15th FC urges states to tax property and professions more to boost finances

The Finance Commission has also advised the union govt to eschew cess to keep Centre-state tax pool in good health, and go for a Constitutional amendment to help states raise profession tax limit

The 15th Finance Commission has broadly agreed with the Centre’s argument that states have been getting about half the divisible pool of taxes. It has also argued that the state governments need to be far more “aggressive” in raising their own tax revenues by tapping into rising property values in urban areas extensively. Asking for measures to tap new sources of revenue, it has advised the Centre to go for a Constitutional amendment to help states periodically revise the limits of profession tax. 

Article 276 of the Constitution caps the levy of profession tax at Rs 2,500. Though it is a tax on income, it is levied by the states. No state levies it at more than Rs 200 per month. The Commission wants more room for states in the tax to add to their revenue.

Trawling through the data of central transfers to states, the Commission headed by N K Singh has shown that the percentage of taxes transferred has remained close to 50 per cent for a decade. This includes the share of central taxes, Finance Commission grants and grants from elsewhere. For the period 2010-15, it was 48.2 per cent and for the period 2015-20, it has averaged somewhat closer to 50.2 per cent. Since the Commission has stuck to the same level of tax-sharing formula between the centre and the states, this will mean that for 15 long years, the states and the Centre will continue to share the divisible pool of taxes equally. “In this broader sense, the States' broad expectations of financial transfers from the Union are being significantly met,” the Commission report notes. 

However, to keep the tax pool in good health, the Commission has also advised the Centre to eschew cess. It has argued that cess and surcharges earmarked by the Union Government have grown over time, amounting to about 15 per cent of its gross revenues, reducing the proportion of revenues eligible for transfers to states from the divisible pool. This balance is the key element of the award of the Commission. These two hypothesis are the most significant element of the tax sharing principle laid down by the Commission.

While the Centre has accepted the award of the Commission, it has not committed to phasing out the cess. Budget 2021 has introduced a series of cesses to finance the Agriculture Infrastructure Fund. The Constitution mandates that every five years a Finance Commission will be set up to advise on how taxes should be shared between the Centre and states and also among the states. 

Reading through the report, it is also obvious that despite giving a lengthy hearing to the state governments, the Commission under Singh has often rapped them for not trying enough to raise resources. Comparing how India fares as a federation against other similar countries, the report observes: “India has a larger (and rising) vertical gap than most federations, reflecting the reality that many States have relied heavily on transfers from the Union rather than on own tax revenues to finance their expenditures.”

It agrees with the contention of the states that their revenue streams are less buoyant but has argued they have not tapped the ones available to them. The Commission has advised them to give more play to tax properties, pointing out that compared to the OECD average, a much smaller proportion of the population pays income and property taxes in India, which needs to be corrected. This puts the states in even more difficult conditions since the whip hand to raise property tax lies with the municipalities. Yet the Commission argues that revenue from “local government property taxes (are) steadily increasing in emerging markets, with better definition of property rights and more empowered municipalities”.

By global standards, property tax revenues in Indian cities are a fraction of (even) the developing country average of about 0.7 per cent of GDP. In many OECD as well as emerging market countries, recurrent taxes on immovable properties have become the most important tax streams for state and local governments, it argues. “Thus, there is considerable potential in moving in this direction, and the lessons point to the need to build a framework for property taxation with universal coverage, limited exemptions, transparent and updated valuations and rates that are broadly in line with global norms”. 

Pushpa Pathak, senior visiting fellow at the Centre for Policy Research had earlier told Business Standard, “There is a kind of rigidity in the urban sector. State governments aren't willing to give more authority and autonomy to (them)…functional devolution hasn't been accompanied by comparable financial devolution”. Pathak, who has also worked with the World Bank and the National Institute of Urban Affairs was doubtful if the states would indeed let that happen.