Indian states are demanding a larger share of central taxes, citing shrinking fiscal space and the Centre's growing reliance on cesses and surcharges, which are not devolved. While the Centre maintains current devolution levels are unsustainable, this standoff highlights a structural imbalance in the nation's fiscal federalism. This dispute threatens states' ability to fund essential services and adapt policies to local needs, against a global trend of increasing sub-federal fiscal autonomy.
The Widening Fiscal Fault Line
Discussions before the Finance Commission have intensified a long-standing dispute between India's central government and its states over the distribution of tax revenues. States are vociferously arguing for a substantial increase in their share of the divisible tax pool, contending that their fiscal capacity is diminishing while expenditure responsibilities escalate. This familiar friction is now exacerbating the inherent tensions within India's federal fiscal structure, as the current 41% share of central taxes allocated to states faces significant pressure.
States' Push for Greater Revenue Autonomy
Nearly two-thirds of India's states are now advocating for their share of central taxes to be raised to 50%. This demand is primarily fueled by the Centre's escalating dependence on cesses and surcharges. These levies, which bypass the divisible pool, have grown substantially, effectively shrinking the resources available for devolution. Between 2011-12 and 2021-22, the share of cesses and surcharges in total tax revenue climbed from 10.4% to 20% [2, 3]. More recently, from 2020-21 to 2022-23, over 15% of gross tax revenue was raised through these non-shareable means [4]. This trend significantly curtails states' fiscal flexibility and their capacity to fund critical public services such as health and education [2, 3]. Some states have even proposed structural changes, like requiring central ratification for new cesses, aiming to regain fiscal control.
Centre's Counterarguments and Fiscal Constraints
The Union government has firmly resisted these demands, asserting that even current levels of resource sharing are fiscally challenging. It argues that when all forms of transfers are accounted for, states effectively receive close to 49% of the Centre's gross revenue. Furthermore, the Centre points to a decline in its own non-debt resources, limiting its fiscal headroom. Constitutionally, the Centre maintains that including cesses and surcharges in the divisible pool is untenable and considers this matter closed [2, 3]. The 16th Finance Commission has retained the vertical devolution share at 41% for the 2026-2031 period, though it has introduced new criteria for horizontal distribution among states, including GDP contribution, while excluding the tax and fiscal effort parameter previously used [9, 21, 24].
Systemic Implications and Global Context
This fiscal standoff reflects a broader trend towards centralization, contrasting with global movements towards increased sub-federal fiscal autonomy. In countries like Germany and the US, sub-federal governments command significantly higher shares of total tax revenue (55% and 47% respectively) compared to the average in developing nations, which tend to be more fiscally centralized [11, 23]. The increasing reliance on tied grants through Centrally Sponsored Schemes (CSS), which constitute about 20% of total fiscal transfers, further limits states' autonomy, often imposing a 'one-size-fits-all' approach to policy implementation [5, 14]. The Comptroller and Auditor General (CAG) has also raised concerns about the potential misuse of cess and surcharge collections, noting significant amounts not being transferred to designated reserve funds [8]. This growing imbalance threatens to fragment India's fiscal federalism, potentially leading to regional disparities and hindering efficient national economic development, while states grapple with underfunded essential services.
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