Towards A More Federal Structure

Context: If States directly collect more tax, they will become less dependent on the Central government.

 

Fiscal federalism challenges in India

• Bias towards Centre in taxation powers:
  • Direct taxes that is, income tax and corporate tax, go entirely to the Central government.
  • Even though Central government is supposed to distribute 41% of its gross tax revenues to the State governments, often politics intervenes, and some States get less and some more, and usually, Central government does not meet the 41% target.
  • Central government has added cess on various items, which adds up to over Rs 3.5 lakh crore; this is not shared with State governments.
• High fiscal dependence on the Centre: At an all-India level, States get 26% of their total revenue from the Central government.
  • Some of the so-called poorer States get up to 50% of their total revenue from the Central government.
• Regional disparity:
  • Maharashtra, Delhi, Karnataka, Tamil Nadu and Gujarat, together contribute 72% of tax revenue.
  • Uttar Pradesh, which has the largest population in India, contributes only 3.12% but gets over 17% of the revenue.
  • For every Rs 100 contributed, southern States get about 51% from the Central government, whereas Bihar gets about 200%.
  • Fears of political marginalisation in the south:
    • As the population growth in the south has come down to near zero and that in central and north India continues to grow, the cross-subsidy from south to north will grow further.
    • As any revision in Lok Sabha seats in 2026 based on population will further reduce numbers for southern states.
  • Pandemic and economic recession would further regional disparity and distress. It is to be noted that regional differences led to violence in Yugoslavia, Sri Lanka and East and West Pakistan.
• Inertia to reform: Making fund allocation fairer is almost impossible because of politics.

Conclusion

• There exists a case for allocating greater economic power to States so that they can directly collect more taxes and be less dependent on Central government. This would improve Centre-State relations.
• Preserving independence and unity of India - A transition to a more federal structure will allow the Centre to focus on external threats (from China, Pakistan and Afghanistan) instead of internal dissensions.