Tax origin not suitable measure for budgetary devolution to states: Study

Using the “origin of tax collection” as an indicator to decide the budgetary devolutions can further accentuate the already high levels of fiscal inequalities among the states, a recent study published in The India Forum journal says.

This comes at a time when southern states have raised concerns on the issue of devolution of resources from the Union government and demanded higher devolutions than what they receive currently as they contribute more to the national pool of taxes. 

“[The] Collection of taxes as an indicator of budgetary fund flow is not an appropriate measure for deciding on the quantum of devolution of taxes to individual states. Use of ‘collection’ as an indicator of devolution can further accentuate the already high levels of fiscal inequalities between the states.

“It is also incorrect to attribute tax collection to a state when tax bases are mobile, especially the direct tax bases. Payment of tax in a state does not necessarily mean that income has been generated in that state,” the study titled ‘Transfer of Budgetary Resources to States’ notes. 

Covering the period between 12th Finance Commission and 15th Finance Commission, the study concludes that devolutions are driven by equity considerations, “distance” of per-capita income of states followed by the size of population and other neutral indicators.

Over this period, the study shows that despite the element of high progressivity, the shares of devolution of the two most income-poor states of the country, Bihar and Uttar Pradesh, have declined to 10.06 per cent and 17.93 per cent from 11.03 per cent and 19.26 per cent respectively. 

“The share of Odisha also declined from 5.16 per cent to 4.53 per cent during this period. The decline of tax devolution to these states happened despite a shift by the 15th Finance Commission in the use of the 2011 Census population instead of the 1971 Census population. The decline in share of most states mentioned here has been a secular decline,” the study notes.

Amongst the major states, an increase in the share of tax devolution over this period was observed in Chhattisgarh, Haryana, Madhya Pradesh, Maharashtra, Punjab, Rajasthan, and West Bengal. 

On the other hand, the decline in Kerala, Karnataka, and Tamil Nadu’s shares was the sharp increase in per-capita income ranking of these states in the last two decades, which is evident from the comparable Gross State Domestic Product (GSDP) data provided by successive Finance Commissions

“It’s not just the southern states like Tamil Nadu and Karnataka that have seen a secular decline in devolution share but also the northern states like Bihar and UP relative to their population. Hence, it is not North vs South but also North and South,” said Pinkai Chakraborty, Vice Chairperson, Institute of Development Studies and author of the study at a talk organised by Centre for Social and Economic Progress (CSEP) on Friday. 

The study concludes that currently there is no mechanism to provide non-debt creating resources to the states for capital expenditure and the inability of the states to finance capital spending over and above the borrowing limits prescribed by the fiscal responsibility act is acting as a limiting factor for capital investment, especially for poorer states. 

“A time-bound reduction in the revenue deficit can enhance capital spending at the state level, and greater flexibility to access market borrowing to states may help augment capital expenditure and growth. Since some of the high-income states also have a large deficit in their revenue account, a prudent management of their finances is critical for fiscal stability,” the study notes.