Fiscal Federalism
Context:
Tamil Nadu Chief Minister M.K. Stalin alleged that the Union government was withholding funds for the State’s vital projects, accusing the government’s tax policies reduce aggregate financial transfers to States, weakening cooperative federalism.
Cooperative Federalism
Cooperative federalism refers to a concept where various states cooperate with each other and with the centre to achieve the goals of growth, development of the states and the nation e.g. All India Service,GST ,NITI Aayog.
Reduction in financial transfers to states:
- Though the Fourteenth and 15th Finance Commission recommended devolving 42% and 41%of Union Net Tax revenues to States respectively , which is a clean 10 percentage points increase over the 13th Finance Commission’s recommendation.
- The Union government not only reduced the financial transfers to States but also increased its own total revenue to increase its discretionary expenditure.
Net tax revenue vs Gross tax revenue:
- The Finance Commissions recommend the States’ share in the net tax revenue of the Union government.
- Fourteenth and Fifteenth Finance Commissions recommended 42%and 41%, respectively, of the net tax revenue to be the shares of States.
- The difference between the gross and the net tax revenue includes
- collection costs,
- tax revenue to be assigned to Union territories,
- cess and surcharges.
- The state share of the gross tax revenue was just 35% in 2015-16 and 30% in 2023-24.
Reasons for Decrease in Financial transfer to states:
- Statutory financial transfers declined from 48.2% to 35.32% of the gross tax revenue of the Union government due to
- Increase in Revenue from Cess and Surcharge: From 5.9% in 2015-16 to 10.8% in 2023-24.These collections are not shared with states and are used for specific Union government schemes.
- Decline in Grants-in-Aid to States: from ₹1.95 lakh crore in 2015-16 to ₹1.65 lakh crore in 2023-24.
- Centralisation of Public Expenditure/Discretionary Grants:
- Centrally Sponsored Schemes (CSS):Increased from ₹2.04 lakh crore in 2015-16 to ₹4.76 lakh crore in 2023-24.
- Central Sector Schemes (CSec):Increased from ₹5.21 lakh crore in 2015-16 to ₹14.68 lakh crore in 2023-24.
Impact of lower fiscal transfer:
- Impact on Cooperative Federalism:Thus the centre retains more than 50% of gross tax revenue leading to lower fiscal space for state governments.
- The discretionary expenditures of the Union government are not being routed through the States’ Budgets, and, therefore, can impact different States in different ways.
- Centrally Sponsored Scheme shared schemes enable States with sufficient funds to secure matching grants, while poorer States must borrow to participate, increasing their liabilities. This exacerbates inter-State financial inequality, as wealthier States leverage Union finances, deepening the fiscal disparity.
- The financial transfers through CSS and C Sec Schemes are non-statutory transfers as they are based on neither any legal provisions nor any formula determined by the Finance Commission.
- Non-statutory grants are tied grants, i.e., they have to be spent on specific schemes for which the grants are allocated. This reduces the freedom of States in conducting public expenditure.
Funds transfer from centre to states It consists of Statutory and non statutory grants.
Statutory grants
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- The distribution of net proceeds of taxes to be shared between the centre and states.(Recommended by Finance commission under Article 280).
- Grants-in-aid to States is of 5 types recommended by the Finance Commission under Article 275(1) and is charged on the consolidated fund of India
The state share of Statutory Grants was around 35% of the total Gross tax revenue in 2023-24.
Non – statutory grants/Discretionary Grants:Article 282 empowers the Union and the States to exercise their spending power to matters not limited to the legislative powers conferred upon them.
The Union government has two routes of direct financial transfers to States, that is,
-
- Centrally Sponsored Schemes (CSS):
- There are 59 such schemes, important ones being MGNREGA,Pradhan Mantri Awas Yojana (PMAY),Swachh Bharat Mission.
- Centrally Sponsored Schemes (CSS):
-
- Central Sector Schemes (CSec Schemes):Central Sector Schemes are schemes entirely funded and implemented by the Union government.
-
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- 700 schemes, important ones being Pradhan Mantri Kaushal Vikas Yojana (PMKVY), Digital India etc.
-
The Non- statutory grants form around 13% of the total Gross tax revenue.
Total fiscal Transfer (48%)= Statutory Grants(35%)+Non- statutory grants(13%).
Way forward:
- Strengthening Finance Commission Mandate:Periodic review and adjustment of revenue-sharing formulas to reflect economic changes.
- Reforming Centrally Sponsored Schemes:Rationalise CSS to provide states with greater flexibility in fund utilisation.
- Enhancing State Revenue Capacities.