In the financial landscape of India, the 15th Finance Commission plays a significant role in the distribution of taxes among states. Critics argue that the commission’s formula is skewed in favor of certain states, leading to considerable inter-state variations. For instance, Tamil Nadu gets back only 29 paise for every one rupee it gives to the Centre, while Uttar Pradesh receives ₹2.73, and Bihar retrieves ₹7.06.
The Mechanism of Tax Distribution Among States
The Centre collects taxes from all the states and allocates them according to the 15th Finance Commission (XVFC)’s formula whose criteria focus on each state’s needs, equity, and performance. Needs are calculated based on population, area, and the state of forest and ecology. Equitability considers the difference in per capita income and performance factors include own tax revenue and lower fertility rate. Out of these, needs are given 40% weightage, equity 45%, and performance 15%.
Furthermore, the XVFC added the fertility rate component to the formula to incentivise states that successfully curbed their fertility levels. However, this aspect carries less weightage than the considerations of equity and needs.
Criticism of the XVFC Formula
Some critics argue that the XVFC formula offers preferential treatment to certain northern states due to the high weightage given to population, causing a steady decline in the share of southern states. Others argue for more significant focus on horizontal equity, where state transfers enable comparable levels of services. But there is also disagreement over whether such transfers should not negatively impact state efficiency and progress.
Overview of the 15th Finance Commission
The Finance Commission (FC) is a constitutionally-mandated body that determines the system and formula for the distribution of tax revenue between the Centre and states, and amongst states themselves. According to Article 280 of the Constitution, the President of India must establish a Finance Commission every five years or sooner if needed.
Key Features of the 15th Finance Commission
The President formed the 15th Finance Commission in November 2017 with NK Singh as its chairman. This Commission’s recommendations will guide tax distributions for the five years from 2021-22 to 2025-26. The central government has accepted the Commission’s recommendation to retain the states’ share in the pool of divisible taxes at 41% until 2025-26.
Impact on State Fiscal Positions
One of the key questions raised in the 2021 UPSC Civil Services Examination was regarding the influence of the 14th Finance Commission of India on the fiscal condition of the states. As highlighted in the question, these commissions and their recommendations have profound impacts on state finances, shaping their fiscal capabilities and influencing the quality and quantity of services they can provide.
In summary, while the Finance Commission’s decisions significantly impact state finances and service delivery, there is ongoing debate about the fairness and efficiency of the current distribution formula.