The north vs south debate is once again in the spotlight. This time over tax devolution. The Southern states of Karnataka, Telangana, Tamil Nadu and Kerala are protesting on February 7th and 8th in the national capital over alleged injustice to the States in tax devolution share and grants-in-aid over the past few years. The southern states, for quite some time now, have been raising concerns claiming that the Centre is being generous to the Northern states while southern states are facing what is being termed as 'fiscal injustice' and 'step motherly treatment'.
Recently, the Karnataka CM has claimed that the state has incurred a loss of 45,000 crores over the last four years. As per the Karnataka government, in the 14th Finance Commission the state received 4.71% of total taxes, which was reduced to 3.64% in the 15th Finance Commission. The reduction of 1.07% has resulted the Rs 45,000 crore loss. If this year’s estimates are taken into account, then this deficit will be Rs 62,098 crore for the five-year period.
The protest also comes at a time when the 16th Finance Commission — the only body that can recommend changes to the tax devolution and grants formulae — has been formed and has to submit its report by October 2025.
Meanwhile, on Monday, during the parliament session, Finance Minister Nirmala Sitharaman and Congress MP Adhir Ranjan Chowdhury locked horns on the alleged withholding of funds for non-BJP government states. While Chowdhury put forward the Karnataka government's claim that the Centre is depriving southern states of their financial dues, especially allocations related to GST compensation, Sitharaman pointed out that devolution to states "happens as per Finance Commission recommendation", and that she had no "discretion" in the allocation of tax revenues.
What is tax devolution?
Tax devolution is the distribution of net proceeds of union taxes and duties by the Centre to the states. It helps states carry out spending on development, welfare and priority-sector projects and schemes. At present, 41% of taxes collected by the Centre is devolved in 14 installments among states during a fiscal year.
The Centre's tax collection comes from States and a part of it is distributed among them, based on the Finance Commission’s (FC) formula.
Finance Commission's formula
As per the 15th Finance Commission, the state’s share on the tax is based on factors including:
- Each state's needs - this includes population, area & forest and ecology
- State's equity - this includes per capita income difference which is the difference between the state's income from the state with the highest income. To maintain interstate equity, the states with lesser Per capita income would be given a higher share.
- State's Performance - Tax revenue and lower fertility rate. The states with lower fertility ratio will be scored higher on this criterion. The Total Fertility Ratio in a specific year is defined as the total number of children that would be born to each woman if she/they were to pass through the childbearing years bearing children according to a current schedule of age-specific fertility rates.
The weight assigned is as follows:
- Income difference - 45%
- Population (2011) - 15%
- Area - 15%
- Forest and Ecology - 10%
- Demographic performance - 12.5%
- Tax Effort - 2.5%
It must also be noted that, the 15th Finance commission introduced weightage to the fertility rate in the formula to reward States which had reduced the fertility levels. While this comes as a benefit to developed states that have pushed the Total Fertility rate (TFR) below replacement rate, the weightage given to the component is relatively lower than equity and need.
Through this assigned weightage, Uttar Pradesh and Bihar have received the largest devolutions for 2020-21, receiving Rs 1,53,342 crore, and Rs 86,039 crore respectively. Meanwhile, Karnataka and Kerala saw the largest decline. Karnataka received Rs 31,180 crore and Kerala received Rs 16,616 crore. During the past six finance commissions, the share of southern States in the shareable taxes has seen a consistent decline.
The Finance Commission is constituted by the President under article 280 of the Constitution, mainly to give its recommendations on distribution of tax revenues between the Union and the States and amongst the States themselves.
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