Towards a more federal structure

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