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.