Once Bitten, Twice Shy

Context: The sharp rise in States’ share in gross tax collections to 50% has failed to assuage their fears on declining devolution.

Rising State’s Share in Fiscal Devolution

• The share of the states in the Centre’s gross tax revenue in the first quarter of 2018- 19 was about 40% it went down to 37% in the same period of 2019-20 but went up sharply to 50% in April-June 2020-21.
• The Fourteenth Finance Commission had raised the states’ share in central taxes by almost 10% points to 42% from 2015-16.
• The Centre and the States equally shared the total gross tax collections:
• In the first quarter of 2020-21 — the states got Rs 1.34 trillion and the Centre got the remaining Rs 1.35 trillion.

Reasons for States’ caution against low tax devolution:

• Fear that current trend might not continue: Past trends do indicate that the first-quarter transfers to the states are always higher, but that share declines by the time the year ends.

• For E.g. the total tax devolution for 2018-19 was 37% of the total gross tax collections by the Centre, down from 40% in the first quarter.
• For E.g. In 2019- 20, the tax share of the states for the full year was 32% of the Centre’s total gross tax collections, down from 37% in the first quarter.

• More devolution because of Centre clearing arrears: States fear that the Centre has expedited the process of clearing of past dues and whenever the situation improves, their share will decline.

• Apprehension about lowering the devolution by the 15th Finance Commission (15th FFC)

• Attempt to force them to share the Centre’s burden of recapitalizing public-sector banks, which will effectively result in a reduction in tax transfer to the states.

• Devising a separate mechanism of funding of defence and internal security – as asked by the Centre to the FFC, might squeeze the share of states.

• Reduction in the total divisible pool: The Centre’s reliance on more cess and surcharges and reduction in the development schemes budget has reduced states’ financial capacity: 

• For E.g. The share of cess and surcharges in the Centre’s gross tax revenue was about 6 %in 2014-15, but it has exceeded 10% in each of the last two years, reducing the devolution share to states.
• The Centre’s decision to curtail expenditure on development schemes has also led to a financial squeeze for many states.

Conclusion: The unpleasant experience of the past several months has made the states wary about both the sudden rise in the transfer of central taxes and the future trends in devolution.