States have often expressed concern regarding their fiscal space being squeezed in recent years. There was a noticeable change that was brought about by the 14th Finance Commission in raising the share of states in the divisible pool of central taxes from 32 per cent to 42 per cent. Both the Finance Commission (FC) and non-Finance Commission (non-FC) grants had broadly remained stable over the period from 12th Finance Commission to the 14th. There was a marginal increase in the grants in the 15th Finance Commission period. It will be interesting to see how these shares are likely to change under the recommendations of the 16th Finance Commission, which has recently submitted its report.
Transfers from the Centre to the states consist of tax devolution and FC and non-FC grants. We can consider trends in these relative to the combined revenue receipts of the Centre and the states with respect to some of the recent FC periods. Tax devolution and FC grants are determined by the FC whereas non-FC grants are at the discretion of the central government. States’ share in central taxes relative to the combined revenue receipts increased from an average of 15 per cent during the 13th FC period to 19.2 per cent in the 14th FC period — an increase of 4.25 percentage points. There was a corresponding increase in the post-transfer share of states by 4.23 percentage points. Thus, the share of states after transfers (fiscal space) increased from 63.85 per cent to 68.08 per cent of combined revenue receipts. Thus, the relative shares of Centre and states were reversed.
There has been, however, a small fall during the 15th FC period in states’ total receipts, that is, their fiscal space, which consists of their own revenue receipts and the total transfers that they receive from the Centre, including the FC transfers. States’ aggregate revenue receipts relative to combined revenue receipts fell from 68.08 per cent in the 14th FC period to 67.39 per cent in the 15th FC period — that is, a reduction of nearly 0.70 per cent points. This was due to a reduction in the share of tax devolution by 1.05 percentage points to 18.2 per cent in the 15th FC period, which was largely offset by an increase in the shares of both FC and non-FC grants so that the total transfers fell only by a margin of 0.23 percentage points of combined revenue receipts. The share of states’ own revenue receipts also fell from 37.72 per cent (14th FC) to 37.35 per cent (15th FC), that is, by a margin of 0.47 percentage points. It may be noted that for the 15th FC period, the number of states had been reduced to 28. Also, the share of non-sharable cesses and surcharges by the central government had been increased.
The situation, however, varies from state to state. It is worthwhile to examine if there is a more serious problem for high-income states. Consider five high-income states, namely, Haryana, Karnataka, Kerala, Maharashtra and Tamil Nadu. The key aggregates determining their fiscal space consist of states’ own revenue receipts and total transfers from the Centre. Comparing the 14th FC with the 13th FC period, there was no change in the fiscal space of these high-income states as the increase in the total transfers from the Centre was offset by a fall in their own revenue receipts. There is, however, a fall in the fiscal space of high-income states when we compare the 15th FC to the 14th FC period averages. This fall, amounting to 0.38 percentage points of combined revenue receipts, is due both to a fall in states’ own revenue receipts (0.25 percentage points) and in transfers from the Centre (0.13 percentage points). Part of the fall in the transfers from the Centre may be due to the increase in the non-sharable cesses and surcharges and partly, it may be due to the devolution formula used. Going forward, states’ GST revenues may be further adversely affected due to the extensive rate reductions in the reforms introduced recently under GST 2.0 and the discontinuation of the GST compensation cess.
Past trends indicate a rise in the share of states in tax devolution and total transfers relative to combined revenue receipts when 14th FC averages are compared with 12th and 13th FC averages. More recently, there has been a small fall in the fiscal space available to the states in general and high-income states in particular. Hopefully, the 16th Finance Commission has taken into account these concerns and modified the weight attached to the distance criterion in the horizontal distribution. The Centre should also refrain from raising non-sharable surcharges and cesses. Needless to say, both the Centre and the states need larger resources to meet multiple challenges. For this, tax receipts of both the Union and state governments must increase. This must be supplemented by a fair system of transfers that strikes a balance between equity and contribution.
Rangarajan is chairman, Madras School of Economics (MSE) and formerly governor, Reserve Bank of India and Srivastava is member, Advisory Council to the Sixteenth Finance Commission and formerly director, MSE. Views expressed are personal
