THE CUT AND THRUST OF TAX DEVOLUTION

The Union government never reconciled to the fact that it had to part with 42 per cent of the divisible pool of taxes to the states, as per the recommendations of the 14th Finance Commission. These recommendations took effect for a five-year period in April 2015. The divisible pool consists of central tax revenues excluding the revenue from cesses and surcharges and the cost of collection. The 13th Commission had recommended 32 per cent and the 14th Commission’s recommendation of 42 per cent was considered excessive. That criticism was unfounded, for unlike the 13th Commission, which had to cover only the non-plan requirements of states, the 14th had to cover both plan and nonplan revenue expenditure requirements. This implied subsuming in the devolution the grants made earlier by the Planning Commission. Besides, unlike past finance commissions, the 14th did not provide for any sectoral grants— for environment, education, health, police or judiciary—and when these are considered, the difference is between

39 per cent and 42 per cent.

After the 14th FinCom’s recommendations were implemented, the Centre took two measures to “undo the damage”. First, it appointed a NITI Aayog committee to review the centrally sponsored schemes, and the committee recommended a restructuring of the schemes so as to substantially increase the ‘matching contribution’ states are required to make. Thus, for schemes such as the National Health Mission, the states are now required to contribute 40 per cent instead of 25 per cent earlier. Second, the discretionary mobilisation of additional revenues was mainly through levies of cesses and surcharges, which are not shareable. The revenue from cesses and surcharges accounted for only 4.2 per cent of the gross central tax revenue in 2015-16 (the first year of the 14th FinCom award) but had climbed to 15 per cent (excluding the GST compensation cess) by 2019-20.

The attempt to persuade the 15th Finance Commission to reduce the devolution to states is manifest even in its terms of reference, which urge consideration of ‘…the impact on the fiscal situation of the Union government of substantially enhanced tax devolution to states following [the] recommendations of the 14th Finance Commission coupled with the continuing imperative of national development programme including New India 2022’. More recently, these terms of reference were amended to state: ‘The Commission shall also examine whether a separate mechanism for funding of defence and internal security ought to be set up, and if so, how such mechanism could be operationalised’. This is mainly to nudge the FinCom to earmark more funds for the Centre. There are also newspaper reports about the Centre sending memos to the commission to reduce the devolution to states. The 15th FinCom’s recommendations will be operational for five years from 2020-21.

On the other hand, the states already face a severe financial crunch. After surrendering their autonomy to levy sales taxes in favour of tax harmonisation through GST, they do not have any broad-based tax handle. They have very little control over GST collections and the compensation scheme for any loss of revenue from the levy of GST is scheduled to expire in 2022-23. The slowing economy causes low growth not only in the states’ own revenues but also in those that devolve from the Centre. This year itself, the states will experience a severe financial crunch due to the reduction in the corporate tax rate: of the estimated hit of Rs 1.42 lakh crore, the states will bear Rs 60,000 crore. In addition, the expansion of schemes such as Ayushman Bharat will substantially pre-empt their resources. With little room for cuts in spending on interest, pensions, wages and salaries, subsidies and transfers, they will either have to miss revenue and fiscal deficit targets or shift the burden of adjustment on their capital expenditures. So far, the capital expenditure of states, at about 3 per cent, has been much higher than the Centre’s, at 1.7 per cent—and reducing their share in the devolution formula will not only severely constrain their resources but also adversely impact public sector capital formation in the country. ■

Cutting the states’ share of tax revenues will also have an adverse effect on public sector capital formation in India