Financial devolution refers to the transfer of financial resources from the central government to state governments in a federal structure. In India, tax sharing between the centre and states has been a long-standing debate around fiscal federalism and centre-state financial relations.
- The sharing of tax revenue and overall transfer of funds to states has significant implications for India’s decentralized governance and cooperative federalism.
- Over the past decade, India has witnessed major reforms in fiscal decentralization policies with the recommendations by the Finance Commissions regarding tax devolution and grants to states.
- The latest Finance Commission recommendations for 2020-2025 along with the implementation of the Goods and Services Tax (GST) in 2017 have brought about noteworthy changes to centre-state fiscal arrangements.
Key Developments in Centre-State Tax Sharing
Some major developments regarding centre-state tax sharing in recent years are:
- Implementation of Goods and Services Tax (GST) in 2017 subsumed multiple indirect taxes into one tax. It stipulated that the centre will collect CGST and IGST while states will collect SGST on intra-state supplies.
- 15th Finance Commission for 2020-2025 period recommended increasing states’ share in the centre’s tax revenue pool to 42% from 32% earlier.
- The commission also suggested performance-based incentives and specific grants for states fulfilling ease of doing business, power sector and agricultural reforms.
- Centre has also started special assistance for states under the ‘Scheme for Special Assistance to States for Capital Expenditure’ to boost capital spending.
Key Statistics on Tax Devolution
The following table represents some key statistics regarding the tax devolved to states over the past 5 years:
| Fiscal Year | Total Tax Revenue (in Rs Lakh Crore) | Total Transfers to States (in Rs Lakh Crore) | Percentage Shared with States |
| 2019-20 | 16.89 | 8.09 | 47.9% |
| 2018-19 | 14.84 | 7.04 | 47.4% |
| 2017-18 | 12.98 | 5.95 | 45.8% |
| 2016-17 | 11.47 | 5.08 | 44.3% |
| 2015-16 | 10.15 | 4.22 | 41.6% |
- As observed, states’ share in centre’s tax pool has increased from 41.6% in 2015-16 to 47.9% in 2019-20.
- In absolute terms, transfers have doubled from Rs 4.22 lakh crore to Rs 8.09 lakh crore during this period.
Key Issues in Financial Devolution
Despite increasing devolution over time, some key issues remain in financial devolution from an economic and fiscal perspective:
- Imbalances across states: Some states with lower development and infrastructure remain at a disadvantage compared to others
- Dependence on centre’s transfers: States still depend heavily on centre for over 50% of their revenue
- Limited revenue sources for states: Major tax bases like income tax, corporation tax and customs duty remain with centre
- Inadequate taxing powers to states: For example, states have little flexibility in GST rates or slabs
- Limited clarity: On resource sharing from cess and surcharges
- Need for performance-based incentives and grants: To promote competition among states
Recent Demands by States
In wake of COVID crisis impacting states’ finances, some key demands put forth by states include:
- Compensating states for GST revenue shortfall below the guaranteed 14% annual growth rate
- Increasing states’ borrowing limits to make up for revenue losses
- Rationalization of centrally sponsored schemes with increased sharing
- More grants and autonomy for health, education and infrastructure spending
Tax devolution is integral for cooperative federalism and decentralized governance envisaged in the Indian Constitution. The centre must balance its resource requirements with states’ needs for delivering public services. Recent reforms represent a step towards achieving this balance. However, further negotiations around revenue sharing, cesses, stabilization of GST and incentivizing performance would be crucial for strengthening India’s fiscal federal structure. Ultimately, both centre and states need to work jointly to boost economic growth and enhance public welfare.