Fair share

Source: The post is based on an article “Fair Share” published in the Business Standard on 11^th August 2022.

Syllabus: GS 2 Issues and Challenges Pertaining to the Federal Structure

Relevance: Fiscal Federalism

News: At a recent meeting of the governing council of the NITI Aayog, the state governments indicated that their resources to fund spending were dwindling.

What are the causes of these tensions between the Union government and many state governments?

Some of this has been caused by the transition to Goods and Services Tax (GST). It has reduced the space available to state governments to raise their own revenue.

The GST compensation payments to the states, which guaranteed increases in state revenues under the GST, have been ended.

The states argue that the Union government is taking too large a share of the tax revenues. As per some reports, the states’ share in taxes collected by the Union government has been between 29-32% since the pandemic hit in 2020-21. This is about 10 percentage points lower than the recommendations that were made by the Fifteenth Finance Commission (FFC).

Further, the Union government is excessively resorting to various kinds of cess and surcharge in the tax mix. For example, the proportion of revenue raised from cess and surcharges has risen from about 6% in 2014 to almost 25% of the tax collection now. Unlike regular taxes, these are not part of the divisible pool. Therefore, the Union government does not have to share these with the states.

What are the arguments in favor of providing more resources to the state governments?

The fact is that the state’s administrative machinery is on the front line of delivering growth and development.

It is the main touchpoint between the citizen and the government.

Underfunded states lead to poor public provision of services, with deleterious effects on both citizen welfare and the growth potential of the economy.

The centralization of the fiscal and spending power through various measures such as cess or centrally sponsored schemes could affect the delivery of quality services to citizens.

What are the arguments against providing more resources to the state governments?

The Centre also has spending commitments and needs resources to finance national security needs and to run welfare programs.

The State governments are often alleged of inefficient and ineffective utilization of funds. Further, the quality of spending is also debated.

What should be done?

In terms of spending, reforms are needed at both levels of the government. For Example, the division of resources should be done more transparently.

The Central government shouldn’t excessively resort to imposition of cess and surcharge, as it distorts the tax system and creates inefficiencies. This could increase resentment among states and lead to greater friction between the Centre and the states.

The Union and state governments work together to take the development process forward.