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Financial transfers from center to state UPSC NOTE

 Declining financial transfers from the central to Indian states

  • Ever since the start of the Fourteenth Finance Commission award period (2015-16), the Union government has been reducing financial transfers to States. 

  • This is particularly strange given that the Fourteenth Finance Commission recommended devolving 42% of Union tax revenues to States.

  • Which is a clean 10 percentage points increase over the 13th Finance Commission’s recommendation. 

  • The 15th  Finance Commission retained this recommendation of 41%, excluding the devolution to Jammu and Kashmir (J&K) and

Ladakh, which were recategorised as Union Territories. 

  • If we include the shares of J&K and Ladakh, it should be 42%. 

  • The Union government not only reduced the financial transfers to States but also increased its own total revenue to increase its discretionary expenditure. 

  • The discretionary expenditures of the Union government are not being routed through the States’ Budgets, and, therefore, can impact different States in different ways.

Raising concerns about federalism and equity in resource distribution

  • The Finance Commissions recommend the States’ share in the net tax revenue of the Union government

  • The difference between the gross and the net tax revenue includes collection costs, tax revenue to be assigned to Union territories, and cess and surcharges. 

  • Though the 14th  and 15th  Finance Commissions recommended 42% and 41%, respectively, of the net tax revenue to be the shares of States, the share of the gross tax revenue was just 35% in 2015-16 and 30% in 2023-24 (Budget Estimate). 

  • While the gross tax revenue of the Union government increased from ₹14.6 lakh crore in 2015-16 to ₹33.6 lakh crore in 2023-24. 

  • The States’ share in the Union tax revenue increased from ₹5.1 lakh crore to ₹10.2 lakh crore between these two years.

  • In other words, the gross tax revenue of the Union government more than doubled while the share of States just doubled. 

  • Grants-in-aid to States is another statutory grant recommended by the Finance Commission

  • The grants-in-aid to States declined in absolute amount from ₹1.95 lakh crore in 2015-16 to ₹1.65 lakh crore in 2023-24

  • Thus, the combined share of the statutory financial transfers in the gross tax revenue of the Union government declined from 48.2% to 35.32%.

  • One of the reasons for the States’ share in gross revenue declining during this period is that the net tax revenue is arrived at after deducting the revenue collections under cess and surcharge, revenue collections from Union Territories, and tax administration expenditure. 

  • Among the three factors, revenue collection through cess and surcharge is the highest and increasing

  • The cess and surcharge collection in 2015-16 was 5.9% (₹85,638 crore) of the gross tax revenue of the Union government, and this ratio increased to 10.8% (₹3.63 lakh crore) in 2023-24.

  • This calculation is excluding the Goods and Services Tax cess that is collected to compensate for the revenue loss of the States due to implementation of GST till June 2022

  • The Union government is increasing tax collection under cess and surcharge categories mainly to implement its own schemes in specific sectors, and at the same time, the revenues so raised need not be shared with the States.

Impact on states

  • The financial transfers through CSS and CSec Schemes are non-statutory transfers as they are based on neither any legal provisions nor any formula determined by the Finance Commission.

  • This non-statutory grant forms 12.6% of gross tax revenue

  • Together with statutory grants, the total financial transfers as a proportion to gross tax revenue were only 47.9% in 2023-24

  • Further, the non-statutory grants are tied grants.

  • They have to be spent on specific schemes for which the grants are allocated

  • This reduces the freedom of States in conducting public expenditure. 

  • In addition to retaining more than 50% of gross tax revenue, the Union government incurs a fiscal deficit to the extent of 5.9% of GDP

  • Thus, the Union government wields enormous financial powers with limited expenditure responsibilities.

  • Further, the 15th  Finance Commission noted that the Union government had argued for the downward revision of States’ share in Union tax revenue from 42% and the Commission retained the share at 41%. 

  • Citing higher expenditure commitments, the Union government may repeat the argument before the 16th Finance Commission



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Learnerz IAS | Concept oriented UPSC Classes in Malayalam: Financial transfers from center to state UPSC NOTE
Financial transfers from center to state UPSC NOTE
Learnerz IAS | Concept oriented UPSC Classes in Malayalam
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