16th Finance Commission
16th Finance Commission
Context
Constitutional under Article 280, the Finance Commission (FC) is tasked with recommending the distribution of financial resources between the Union and the States. The 16th Finance Commission’s recommendations are pivotal in shaping India's fiscal federalism, balancing the needs of a developing economy with the demands of individual states.
Vertical Devolution
Vertical devolution refers to the share of the Divisible Pool of central taxes that is distributed to the states.
- Current Allocation: The share remains at 41%, maintaining the status quo established by the 15th Finance Commission.
- Effective Share: Despite the 41% figure, the actual transfer is often lower because the "divisible pool" excludes certain collections like Cess and Surcharges.
Horizontal Devolution: Distribution Criteria
Horizontal devolution determines how the 41% share is divided among the various states based on specific socioeconomic and geographic metrics.
|
Criteria |
Weightage Change |
Rationale |
|
Income Distance |
Reduced (45% → 42.5%) |
Encourages states to improve fiscal performance rather than rewarding lower income levels. |
|
Population |
Increased |
Aims to address the needs of more populous states, shifting away from penalizing those with higher growth. |
|
Area |
Reduced (15% → 10%) |
Minimizes the bias toward geographically large states with low density. |
|
Forest Cover |
10% (Unchanged) |
Recognizes the ecological contribution and the opportunity cost of maintaining forest land. |
|
GDP Contribution |
New Criteria |
Replaced "Tax Effort" to reward states with high economic output and productivity. |
Major Concern: Cess and Surcharge
A significant friction point in Center-State relations is the rising reliance on Cess and Surcharges.
- The "Shrinking" Pool: Currently, the Union government collects approximately 11% of its total revenue through these instruments.
- Exclusion from Sharing: Under Article 270, these collections are not part of the divisible pool, meaning they are kept entirely by the Center.
- Impact: This effectively reduces the states' actual share to 41% of only about 89% of the total tax revenue collected.
Key Financial Concepts
To understand the devolution process, it is essential to distinguish between the types of levies collected by the government:
- Tax: General revenue collected for the common good; mandated to be shared with states.
- Cess (Article 270): A tax levied for a specific purpose (e.g., Krishi Kalyan Cess or Education Cess). The proceeds must be used only for that specified intent.
- Surcharge (Article 271): An additional tax on top of the existing tax (a "tax on tax"), usually applied to high-income earners.
Way Forward
- Widening the Divisible Pool: There is a growing demand from states to include a portion of Cess and Surcharges in the divisible pool to ensure truer fiscal federalism.
- Outcome-Based Incentives: Future commissions may need to further refine the "GDP Contribution" metric to ensure it doesn't lead to widening inequality between industrial and agrarian states.
- Stability in Transfers: Ensuring that the Union government minimizes arbitrary changes in tax structures that impact the states' predictable revenue streams.
Conclusion
The 16th Finance Commission marks a shift toward rewarding economic performance while navigating the complexities of population dynamics. However, the structural issue of Cess and Surcharges remains a hurdle for states seeking a more equitable share of the national revenue pie.