Issue with Financial Transfers to States-Union Government’s Reins on Financial Transfers to States

Source: The post issue with financial transfers to states has been created, based on the article “Union government’s reins on financial transfers to States” published in “The Hindu” on 7th February 2024.

UPSC Syllabus Topic: GS paper2- polity- issues and challenges pertaining to the federal structure, devolution of powers and finances up to local levels and challenges therein. And GS Paper3- Indian economy- resource mobilisation

News: The article discusses how the Indian central government has reduced financial transfers to states, increased its own revenue through taxes and surcharges, and is spending more on its schemes rather than distributing funds to states.

What is The Issue with Financial Transfers to States?

Reduced Financial Transfers: Despite recommendations (from finance commission) for states to receive 42% and 41% of the net tax revenue (revenue after deductions for collection costs, sharing with Union Territories, and cess and surcharges), they actually received a smaller share of the gross tax revenue (total collected revenue before any deductions): just 35% in 2015-16 and 30% in 2023-24.

Growth in Union Government’s Revenue: The Union government’s tax revenue more than doubled from ₹14.6 lakh crore in 2015-16 to ₹33.6 lakh crore in 2023-24. However, the states’ share doubled from ₹5.1 lakh crore to ₹10.2 lakh crore, indicating a disproportionate increase.

Decrease in Grants-in-Aid: Direct financial support to states, in the form of grants-in-aid, declined from ₹1.95 lakh crore in 2015-16 to ₹1.65 lakh crore in 2023-24.

Increase in Cess and Surcharge: The collection from cess and surcharge, which is not shared with states, rose from 5.9% of the Union government’s tax revenue in 2015-16 to 10.8% in 2023-24.

Centralisation of Expenditure: The Union government increased spending on its schemes like CSS and CSec, from ₹2.04 lakh crore to ₹4.76 lakh crore and ₹5.21 lakh crore to ₹14.68 lakh crore, respectively, reducing states’ financial autonomy.

What Impact does This have on State Finances?

Strain on State Budgets: Due to reduced transfers and grants, states face challenges in financing their programs and initiatives, impacting their ability to deliver public services effectively.

Impact on Less Wealthy States: Poorer states struggle more due to these financial constraints, exacerbating the inequality between states in terms of financial resources and development capabilities.

Limited Fiscal Autonomy for States: With the central government’s increased control over financial resources, states have less freedom and flexibility in their spending, impacting their ability to address local needs and priorities.

Impact on Fiscal Federalism: This trend towards more centralised control over finances, with less revenue sharing with states, goes against the principles of cooperative federalism.

Potential Bias in Resource Allocation: The possibility of the Union government favoring certain states or regions through Central Sector Schemes, due to their complete funding by the central government, raises concerns of unequal treatment among states.

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Way forward

To promote balanced fiscal federalism, the Union government should adhere to the Finance Commission’s recommendations on revenue sharing. Increasing statutory transfers to states and ensuring equitable allocation of funds across all regions are vital. This approach will enhance states’ financial autonomy and support equitable development.

Question for practice:

Evaluate the impact of Indian central government’s financial policies on state finances and fiscal federalism.