The latest agitations by the governments of Kerala and Karnataka, and the help prolonged by a number of State governments, have highlighted many disquieting points in the follow of fiscal federalism in India. These agitations present that the newly constituted sixteenth Finance Commission (FC) must proceed critically and innovatively to justly tackle complaints of accelerating vertical and horizontal inequalities in devolution.
Within the area of vertical devolution — that’s the sharing of assets between the Union and States — there are two disturbing traits that want pressing redressal. First, the Union authorities has sought to maintain an growing share of its proceeds out of the divisible pool in order that they needn’t be shared with States. Secondly, it has additionally not been devolving the shares of internet proceeds to the States as mandated by successive FCs.
The shrinking divisible pool
The internet divisible pool, or internet proceeds, is that a part of the gross tax income from which a share must be vertically devolved by the Union to all States. Such shares are assigned by every FC for a five-year interval. Earlier, all company taxes and customs duties have been absolutely absorbed by the Union, and solely earnings taxes and excise duties have been shared with the States. However, with modifications over the years, culminating in a constitutional modification in 2000, all taxes of the Union have been added to the internet proceeds. But there was a catch — cesses and surcharges underneath Article 270 and Article 271 have been saved out of the internet proceeds. In the previous, such exclusion of cesses and surcharges have been based mostly on particular FC suggestions. But the modification in 2000 offered a constitutional foundation for it. Presently, the internet proceeds consists of the gross tax income after the deduction of cesses, surcharges and the price of assortment of taxes.
Over the previous decade or extra, a number of cesses and surcharges have been launched by the Union authorities. When the Goods and Services Tax (GST) was initiated in 2017, the expectation was that many cesses and surcharges can be discarded and subsumed into the GST system. On the opposite, new cesses and surcharges continued to be launched, and many aged cesses and surcharges remained outdoors the GST system. For occasion, the Agriculture Infrastructure and Development Cess was launched as latest as in 2021-22. Similarly, when the Health and Education Cess was launched in 2017-18, it simply changed the Primary Education and Secondary Education cess on direct taxes. The growth of cesses and surcharges have led to the exclusion of an growing share of the gross tax income from internet proceeds. Interestingly, there’s conflicting data launched by the authorities on the quantum of cesses and surcharges. In December 2022, responding to a query raised in the Rajya Sabha, the authorities acknowledged that the share of cesses and surcharges in the gross tax income was 18.2% in 2019-20, 25.1% in 2020-21 and 28.1% in 2021-22. But responding to a different query in the Lok Sabha in March 2023, the authorities acknowledged that the corresponding shares have been 15.6% in 2019-20, 20.5% in 2020-21 and 18.4% in 2021-22.
To get hold of extra correct estimates of cesses and surcharges, this text makes use of disaggregated knowledge from price range paperwork between 2009-10 and 2024-25. The assortment of every kind of cess and surcharge was individually recorded and added up, after giving due consideration to their occasional abolishment and/or merger with different taxes. The complete assortment of cesses and surcharges rose from ₹70,559 crore in 2009-10 to ₹6.6 lakh crore in 2023-24 (RE) and ₹7 lakh crore in 2024-25 (BE). These collections embrace the GST compensation cess, which is given to the States as per statutory necessities. If we deduct the GST compensation cess, the assortment of cesses and surcharges rose from ₹70,559 crore in 2009-10 to ₹5.1 lakh crore in 2023-24 (RE) and ₹5.5 lakh crore in 2024-25 (BE). Considered as a share of the gross tax income, cesses and surcharges fell from 11.3% in 2009-10 to 9.5% in 2014-15, however then rose to fifteen.3% in 2018-19, a peak of 20.2% in 2020-21 and 16.3% in 2022-23. As per the tentative figures for 2023-24, cesses and surcharges are estimated at 14.8% of the gross tax income, which continues to be greater than the corresponding shares in 2009-10 or 2014-15 (see Chart 1).
Between 2009-10 and 2023-24, a cumulative complete of ₹36.6 lakh crore was collected by the Union authorities as cesses and surcharges. An extra ₹5.5 lakh crore is projected to be collected as cesses and surcharges in 2024-25. This quantity was not shared with States and was used solely by the Union authorities.
Rise in tied transfers
The Union authorities might argue that part of this quantity was used to finance centrally sponsored schemes and central sector schemes, whereas one other half was used to supply non-plan grants or capital transfers to States. The downside, nonetheless, is that such transfers are not untied as is the case with the devolution of State’s share in central taxes. In centrally sponsored schemes, about 40% of the price have to be borne by the State governments. Even in central sector schemes, the contribution of the Union authorities is usually meagre, and the State governments are compelled to contribute considerably bigger quantities to run the schemes meaningfully.
Even when State governments contribute a lion’s share in implementing a central mission, the Union authorities typically tries to usurp credit score by insisting on displaying the Prime Minister’s {photograph} or different types of labelling. Recent disputes over labelling in the Ayushman Bharat wellness centres is one such instance. Similarly, a number of grants given to the States are contingent on fulfilment of conditionalities — and a few of these conditionalities embrace the insistence on labelling. Finally, most capital transfers given to the States are loans, which have to be repaid to the Union authorities
The backside line is that none of the transfers to the States outdoors the FC suggestions are both unconditional or appropriate to satisfy their context-specific wants. Instead, they are likely to reaffirm a centralising tendency in the fiscal realm — one which successfully tends to push the Union-State relationship right into a patron-client relationship. Any purported deviation from the pointers or a failure to satisfy the imposed conditionalities can result in the denial of such assets.
The share of States in central taxes is, thus, a gold normal in any evaluation of fiscal federalism. It is a matter of deep fear, then, that the Union authorities more and more pays much less of untied transfers to States and retains extra of the gross tax income as cesses and surcharges. The substitution of such untied transfers with central schemes doesn’t ameliorate the loss; as an alternative, it inserts rigidities in Union-State relations and finally ends up diluting the spirit of cooperative fiscal federalism.
The CAG indictments
Cesses and surcharges have additionally been subjected to important scrutiny by the Comptroller and Auditor General (CAG). All cesses have to be transferred to a reserve fund in the Public Account of India after their assortment. In its stories the CAG has uncovered quite a few situations of both non-transfer or quick switch of the collected quantities to the respective funds. A CAG report in 2023 famous that if ₹52,732 crore was collected in direction of the Health and Education Cess in 2021-22, solely ₹31,788 crore (or 60%) was transferred to the reserve fund of Prarambhik Shikha Kosh. The Research and Development Cess have to be transferred to the Fund for Technology Development and Application. A CAG report in 2019 famous that the complete assortment of Research and Development Cess between 1996-97 and 2017-18 was ₹8,077 crore, however solely ₹779 crore (or 9.6%) was transferred to the Fund.
The Swatchh Bharat Cess have to be transferred to the Rashtriya Swachhata Kosh. The extent of quick switch to the Kosh between 2015–16 and 2017–18 was ₹4,891 crore. The extent of quick switch between 2010–11 and 2017–18 underneath the Road Cess was ₹72,726 crore and underneath the Clean Energy Cess was ₹44,505 crore.
Non-transfers and quick transfers of cesses defeat the logic of their assortment. It additionally reaffirms the view that cesses and surcharges are only a ruse to divert growing quantum of funds away from the divisible pool to satisfy different monetary necessities of the Union authorities.
Deviations from FC suggestions
Speaking in Parliament on February 8, 2024, the Union Finance Minister claimed: “whatever the Finance Commission has recommended [as the rate of devolution], I follow it to the last word”. How strong is that this declare?
We have seen that a good portion of the gross tax income is retained by the Union authorities as cesses and surcharges. One might disagree with such a retention, however it has some foundation in constitutional provisions. However, what has occurred to the advice of the FCs {that a} sure share of the internet proceeds have to be shared with all States? These shares have been stipulated as 32% by the thirteenth FC (2010 to 2015), 42% by the 14th FC (2015 to 2020), and 41% by the fifteenth FC (2020 to 2025).
Annual estimates of internet proceeds may be obtained by deducting cesses, surcharges, and prices of assortment of taxes from the gross tax income. These estimates of internet proceeds may be in contrast in opposition to the “States’ share of central taxes” in annually to verify if they amounted to the FC-stipulated proportion of the internet proceeds. It seems that the Union authorities has not been sharing even the FC-recommended shares of internet proceeds with the States. The States’ share of central taxes as a proportion of internet proceeds was under the suggestions of the respective FCs for many years (see Chart 2).
The common of the annual shares of devolution was 31.1% throughout the thirteenth FC interval, 40.3% throughout the 14th FC interval and 38.1% throughout the fifteenth FC interval. The shortfall was widest throughout the ongoing interval of the fifteenth FC, for which the declare of “to the last word” has been supplied.
If we add cesses and surcharges to the internet proceeds — to create a revised divisible pool — the share of devolution would fall even additional to twenty-eight% throughout the thirteenth FC interval, 35.1% throughout the 14th FC interval and 31.7% throughout the fifteenth FC interval. What do these shortfalls vis-a-vis FC suggestions quantity to in quantum phrases? Between 2009-10 and 2024-25 (BE), the cumulative quantity not devolved to the States was ₹5.61 lakh crore (see Chart 3).
The complete quantities not devolved to the States have been ₹44,922 crore throughout the thirteenth FC interval, ₹1.36 lakh crore throughout the 14th FC interval and a whopping ₹3.69 lakh crore throughout the fifteenth FC interval (together with 2024-25 BE). The failure to devolve these funds to States have to be handled as a hanging constitutional impropriety.
The agenda of reform
To conclude, sharing of assets from the divisible pool, and the extent of cesses and surcharges, have to be issues of important significance for the sixteenth FC. The FC should take initiative to appropriate historic wrongs in vertical devolution by compensations to the States. It should instruct the Union authorities to publish correct estimates of “net proceeds” in the price range paperwork. It should additionally prepare to supply shortfalls in devolution over the final decade as a lump sum untied grant to States. On its half, the Union authorities should legislatively act to have strict limits on the assortment of cesses and surcharges; cesses and surcharges ought to robotically expire after a brief interval and should not be rechristened underneath one other identify. Apart from addressing rightful complaints on the inequalities in horizontal devolution, the stance of the sixteenth FC on vertical devolution can be important to the survival of fiscal federalism in India.
R. Ramakumar teaches at the School of Development Studies, TISS, Mumbai.
