The States:Gross Inequity, Net Loss

Six years and five governments later, the recommendation of the Tenth Finance Commission (TFC) on the devolution of taxes to state governments has finally been approved by the central government. But as would be expected from any arbiter who is a party to the dispute, the changes which have been introduced have virtually negated the favourable impact that the system of devolution proposed by the TFC -- share of states to be 29 per cent of the gross tax revenues -- would have had on state finances.

Without assigning any reason or rationale, the `gross tax revenues' has been converted into `net tax revenues'. By changing the divisible pool from gross to net, the central government has reduced the divisible pool by more than Rs 2,000 crore, which amounts to 1 per cent of the total gross tax collection in the current fiscal year.

 

Even when the Tenth Finance Commission was discussing the idea of pooling all central taxes and giving states a share, the ministry of finance had opposed it on the grounds that divisible pool was going to be too large. This view is not correct if it is recognised that customs duties -- the only major revenue source sharing of which worried them -- would increasingly be used as a countervailing measure to union excise duties such that it is more a tool of policy rather than a revenue source under the liberalisation regime.

While the TFC report outlined that the 29 per cent share of states comprised of 26 per cent of all taxes and 3 per cent as a compensation for abolishing the tax rental arrangement of additional excise duties in lieu of sales tax, it was not explicitly mentioned how the figure of 26 per cent had been arrived at.

At the time of the TFCs deliberations, the average share of the states in gross receipts of central taxes was 24.31 for the years 1990-95. The TFC decided to increase the figure because it decided to give the central government a major stake in the collection of taxes under Article 269 by including it in the central divisible pool. Article 269 contains taxes that are to be levied and collected by the Centre but assigned to the states. But under the TFCs dispensation, the Centre would get 71 per cent of collections from taxes under this article except central sales tax and consignment tax. The basis of this decision was the perennial complaint by states that the Centre had not exploited this source adequately as it had no share in the collections.

The hike in the share of states from about 24 per cent to 26 per cent was based on the premise that the states would forgo an earmarked source of revenue. It was estimated that the two per cent increase would cover what the states would have received had Article 269 been adequately tapped by the Centre.

But all this has virtually come to a naught now and the states are in the danger of actually being worse off under the new system. In the last six years -- between the time the TFC report was submitted and now -- the share of the states in central taxes has now increased largely because of a change in the composition of central taxes. The states share has moved up from 24.3 per cent which was the base for TFCs calculations to a little above 27 per cent in the budget of 2000-2001. This figure goes up to 27.5 per cent when adjusted for grants in lieu of railway passenger fare. The TFC had recommended abolishing this.

At the same time, the conversion of `gross' to `net' has reduced the 29 per cent recommended by the TFC to 28.5 per cent. Thus, the increase in the share of states is going to be just about 1 per cent. But with Article 269 taxes having been made a part of the pool, the states are net losers by 1 per cent since the TFC had estimated the compensation for Article 269 taxes at 2 per cent. This makes the new system unfair and biased even before it has taken off.