Towards a more federal structure

Why India needs better tax sharing mechanism between Center and States? 

Context: 

The current policy of tax sharing between center and states will increase the regional differences.  

Current policy of Tax sharing mechanism in India: 

In India, direct taxes go entirely to the Central government. State governments get funds from the Central government according to the Finance Commission’s recommendations. Though this is based on a formula, often politics intervenes, and some States get less and some more. 

• After the Fifteenth Finance Commision recommendation, the Central government is supposed to distribute 41% of its gross tax revenues (reduced from 42% after the formation of new Union Territories in Jammu and Kashmir) to the State governments. 

Challenges with the present tax sharing mechanism:  

• Usually, the Central government does not meet the 41% target. Various States governments either file petitions or come into conflict with the Central government on this issue. 
• The issue of Cesses: Central government has added cess on various items which adds up to over ₹3.5 lakh crore. This is not shared with the State governments. 
• More economic power to the Central government: 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 allows ruling parties at the Centre to use these funds to their advantage. 
• Regional disparity: Maharashtra, Delhi and Karnataka, Tamil Nadu and Gujarat contribute 72% of the tax revenue. But they receive only miniscule share. On the other hand, Uttar Pradesh, which has the largest population in India, contributes only 3.12% but gets over 17% of the revenue distributed by the Central government. 
• Revenue distribution formula: The formula gives more weightage to population and poverty levels. The population growth rates in the southern states have come down to near zero. On the other hand, population in central and north India continues to grow. This make ever growing of cross subsidy from the south to the north.  

Suggestions: 

• Provide greater economic power to states: This will make states to directly collect more taxes and be less dependent on the Central government. This is in line with the international practices. In the U.S., both the federal and State governments collect direct taxes from individuals and corporations. This is true in Switzerland and some other countries as well.   

A transition to a more federal structure will allow the Centre to focus on external threats instead of internal dissensions. 

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Source: The Hindu