Tax Contribution by States Needs to be Revisited – Issue of Tax Distribution Among State

Source: The post issue regarding Tax Contribution has been created, based on the article “Tax contribution by States needs to be revisited” published in “The Hindu” on 23rd January 2024.

UPSC Syllabus Topic:  GS Paper 3 – Indian Economy – mobilization of resources

Tax Contribution by States Needs to be Revisited,  The article discusses how the Finance Commission in India decides the share of tax revenue for each state.

How were Taxes Historically Distributed?

Until the 10th Finance Commission (up to 2000), state shares in Union tax revenue were limited to personal income tax and Union excise duties.

Population was a major factor, with 80% to 90% weight in the distribution formula for income tax in the first seven Finance Commissions.

For Union excise duties, due to a lack of consumption data, states’ tax contribution was not a determinant.

Post-2000, all central tax revenues were combined for distribution, with a unified formula for both income tax and Union excise duties, focusing more on equity.

In the 15th Finance Commission, the distribution formula included tax effort (2.5% weight) and demographic performance (12.5% weight), along with equity indicators like per capita income and population as per the 2011 Census.

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What are The Issues Regarding Tax Contribution?

Primary Issue: The main issue is whether states with higher tax contributions should receive a larger share of Union tax revenue. States’ Viewpoint: States with substantial tax contributions argue for greater recognition in the distribution formula.

Historical Weightage: Historically, state tax contributions were given limited weight (10% to 20%) in the revenue distribution formula.

Complexity in Attribution: Accurately attributing income tax revenue to specific states is challenging, complicating the assessment of contributions. States’ Demand: States with significant income tax collections demand higher weighting for their tax contributions.

Balance Challenge: The debate involves finding a balance between rewarding states for economic efficiency and maintaining equitable distribution among all states.

What Should be Done?

1. Include State GST contributions in the distribution formula as a measure of efficiency. This is because GST, being a consumption-based tax, accurately reflects a state’s tax base and is equally divided between the State and Central governments.
2. Consider the relative share of petroleum consumption by States as another efficiency indicator. Since petroleum taxes are outside GST, this reflects the State’s contribution to Union excise duties and customs duties on petroleum products.
3. Assign significant weightage (suggested at least 33%) to these efficiency indicators (GST revenue and petroleum consumption) in the distribution formula. This is supported by the fact that GST revenue and petroleum consumption are stable and fair measures of a state’s contribution to the national exchequer.
4. Maintain a balance between efficiency and equity indicators in the distribution formula. Equity factors like population, area, and income levels must be considered alongside efficiency to ensure a fair and equitable allocation of Union tax revenues among States.

Question for practice:

Discuss the key issues and proposed solutions related to the distribution of Union tax revenue among Indian states.