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Towards a more federal structure

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June 23, 2021

What is the issue?

  • India’s choice of a Union, instead of a federal set up, post-independence has had the effect of making states more dependent on the Centre.
  • It calls for a rethink, especially given the financial challenges posed by this form.

How does revenue distribution work?

  • Direct taxes include income tax and corporate tax.
  • In the U.S., both the federal and State governments collect such taxes from individuals and corporations.
  • The federal government distributes about 15% of its revenues.
  • Unlike this, in India, direct taxes go entirely to the Central government.
  • The Central government is then supposed to distribute 41% of its gross tax revenues to the State governments.

What are the concerns?

  • State governments get funds from the Central government according to the Finance Commission’s recommendations, based on some formula.
  • But often politics intervenes and some States get less and some more.
  • Usually the Central government does not meet the 41% target.
  • Meanwhile, the Central government has added cess on various items.
  • This adds up to over Rs.3.5 lakh crore.
  • This (cess) is not shared with the State governments.
  • At an all-India level, the States get 26% of their total revenue from the Central government.
  • Some of the so-called poorer States get up to 50% of their total revenue from the Central government.
  • This makes them even more dependent and gives more economic power to the Central government.

How is regional disparity reflected?

  • Maharashtra, Delhi and Karnataka contribute the major share of taxes to the government.
  • These three regions along with Tamil Nadu and Gujarat contribute 72% of the tax revenue.
  • Uttar Pradesh, which has the largest population in India, contributes only 3.12%.
  • But, it gets over 17% of the revenue distributed by the Central government.
  • Revenue distribution is based on complex considerations including population and poverty levels.
  • For every Rs.100 contributed, southern States get about 51% from the Central government, whereas Bihar gets about 200%.
  • The population growth rates in the south have come down to near zero.
  • On the other hand, population continues to grow in central and north India.
  • So, the cross subsidy from the south to the north will continue to grow.

What is the way forward?

  • Making the fund allocation fairer is almost impossible because of politics.
  • So, looking beyond the current framework is pertinent.
  • One step could be to provide greater economic power to the States.
  • With this, they can directly collect more taxes and be less dependent on the Central government.
  • For poorer States, a period of transition is perhaps required.
  • In all, a transition to a more federal structure would improve Centre-State relations.


Source: The Hindu

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