The North-South divide: The 'fiscal injustice' rhetoric is biased

Karnataka Congress member of Parliament, D K Suresh's comment on budgetary allocations announced by the finance minister on February 1 speculated that southern states suffered fiscal injustice. He warned that South India could split into a "separate nation". The inherent biases in this argument have to be exposed, and the idea given a quick burial.

D K Suresh said, "The Centre is not properly giving the right share of GST and direct taxes to South Indian states. The South Indian states are facing injustice. The money collected from southern states is being given to North Indian states. If this continues, we will be forced to demand a separate country." He underlined the threat by reiterating that if the 'injustice' is not rectified and "if we do not condemn it today, then in the coming days a necessity will arise to put forth a proposal for a separate nation (for the south)."

On the face of it, the single North Indian state of Uttar Pradesh (UP) has received nearly 18 per cent allocation from the central pool of taxes compared to the 15.5 per cent all five south Indian states have received collectively (Andhra Pradesh and Tamil Nadu about four per cent, Karnataka 3.6 per cent, Telangana 2 per cent, and Kerala 1.9 per cent). The gross allocation of UP at Rs 1.83 trillion is the highest of any Indian state and way above the entire southern zone, which performs better on all counts ranging from investments, job creation, infrastructure, social security and welfare schemes, governance and population control.

Therefore, the people of the southern states may be swayed by the rhetoric that they contribute the most to the tax kitty but get precious little in return. This narrative feeds the argument that they -- the advanced states of the South -- are subsidising the laggard states of the North. In other words, lack of population control and bad governance are being rewarded and also incentivised. It verges on upending the very model of cooperation that holds India together as a union of states.

However, the sharing of the tax pool is based on the principle that the Indian Union must pull up poorer states and bring them on par with the more efficient and wealthier ones. Fiscal transfer is one of the most effective ways of ensuring this. Will DK Suresh Kumar apply the same argument to his own state? Would he say that metropolitan areas like Bengaluru city, which contribute more to the tax kitty, suffer "fiscal injustice" because the taxes collected from there are spent on less developed rural areas?

The redistribution of revenue to the states is done based on principles periodically laid down by the Finance Commission for equitable allocation of the tax purse.

The Fifteenth Finance Commission set up the following criteria, each with different weightage, in distributing central taxes to the states: income distance or the distance of the state's income from the state with the highest income (weightage 45 per cent), the population as in the 2011 census (15 per cent), area (15 per cent), forest and ecology (10 per cent), demographic performance (12.5 per cent) and tax effort (2.5 per cent). Only two of the criteria, demographic performance and tax effort, explicitly incentivised the states that perform well -states with lower fertility ratios and higher tax collection efficiency- and are rewarded at present.

One could propose a re-examination of the weightage given to individual criteria by the Sixteenth Finance Commission, which was announced on December 31, 2023. Perhaps leaders of Southern states could argue for increasing the weightage of criteria like demographic performance and tax efficiency.

However, it should not be forgotten that in the 1950s and 1960s, the North Indian states subsidised Southern and Western India as part of the cooperative model of nation-building. Bihar was the fourth richest state of India at the time of Independence. The mineral-rich state (which included Jharkhand at that time) contributed to the growth of today's developed states through the freight equalisation scheme (later phased out in favour of fiscal measures). This neutralised the comparative advantage of mineral-rich states like Bihar but helped the industrialisation of states located far away by making raw materials available at constant prices to all.

Even today, the growth in the southern states can only be sustained with labour migration from North India. The replacement rate of fertility that keeps the population stabilised is 2.1 -- below this rate, the population begins to fall gradually. The replacement fertility rate of the southern states is falling- it ranges from 1.4 for Tamil Nadu, 1.5 for Andhra, 1.6 for Kerala, and 1.6 for Karnataka. In contrast, the replacement fertility rate is 3 for Bihar, 2.7 for UP, 2.6 for Madhya Pradesh and 2.4 for Rajasthan.

As the population of the southern states ages and its growth shrinks, labour migration from North India, both young skilled and unskilled workers, will become necessary to sustain growth. This is already evident today in states like Tamil Nadu, Kerala and Karnataka. North India is also an expanding market for the goods the South produces.

Perhaps the rhetoric of the North-South fiscal divide has gained political traction because of the impending delimitation exercise for Lok Sabha and assembly constituencies scheduled for 2026. The southern states could find it unfair that despite their efforts at growth, development and welfare, their political representation is likely to shrink based on the criteria of their smaller populations. While the delayed 2021 census, which would be the basis of the delimitation, is yet to be carried out, such fears of the southern states must be addressed with appropriate modalities to ensure that good governance is not penalised.

For now, the debate about the North-South divide is a double-edged sword for the national parties. Only the regional parties can afford to amplify the narrative of injustice to the South for electoral gains. It is important, however, that the political class as a whole work harder towards making the debate on redistribution of the tax pool more granular and less rhetorical while maintaining the principle of equity.