Resource allocation: Finance Commission needs to address multiple issues

The 16th Finance Commission has about six months to submit its report. Its recommendations will cover five years starting April 1, 2026. As reported by this newspaper last week, the Finance Commission has visited most states to record their views on the sharing of fiscal resources. The Finance Commission is constituted under Article 280 of the Constitution, mainly to recommend the distribution of tax revenues between the Union and the state governments. The commission, in its visits to states, is reported to have received at least three kinds of views. First, most states, including those run by the National Democratic Alliance, want the state share in the divisible pool to be increased to 45-50 per cent from the current 41 per cent.

 

The second important issue raised by some states was that of the increased use of cesses and surcharges by the Union. While the Constitution empowers the Union government to levy cesses and surcharges, those are not part of the divisible pool and they remain with the Union government. In a way, the views on higher devolution and cess are interlinked. At the given stage of India’s development, Budgets at both the Union and state levels have various competing demands, and governments want to have more resources at their command. Therefore, while states want their share in the divisible pool to be increased, the Union’s dependence on cesses and surcharges has increased. An analysis by this newspaper showed that tax devolution to states is budgeted only at 33.3 per cent of the Union’s gross tax receipts in the current year, which is marginally better than the revised estimate for last year but significantly below the recommendation of the 15th Finance Commission at 41 per cent, mainly because of collection through cesses and surcharges. An effort should be made to reduce the dependence of the Union on cesses and surcharges. The commission can guide the discussion in this context and recommend ways to make the division more transparent.

 

The third view came from Tamil Nadu. It was suggested that a state’s contribution to the country’s gross domestic product should also be taken into account in the distribution of tax revenue. This would essentially mean that bigger and richer states will get more funds. Such states have often complained that they tend to lose out. Besides the states’ views on these issues, the Commission would also be expected to take the discussion forward in at least two other areas. One, there is a need to reduce and rationalise centrally sponsored schemes (CCS). States would be better off if more funds were untied. This will give them the freedom to design spending programmes in accordance with local needs. Different states are at different levels of development. Structurally lower allocations for CCS can also make room for increasing the divisible pool over time.

 

Two, the increasing level of debt in several states needs to be addressed. As economists Barry Eichengreen and Poonam Gupta have shown in a recent paper, more than half the Indian states have debt exceeding 30 per cent of gross state domestic product (GSDP). This is expected to rise in several states to alarming levels. Debt in Punjab is projected to top 50 per cent of GSDP, while four other states would have debt levels in excess of 40 per cent under the baseline scenario in 2027-28. Higher debt in states will create growth and stability risks. Budget management in some states will need to be adjusted. The commission can incentivise this process.