States' Share in Central Taxes

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Volume-5, Issue-4, August-2015 International Journal of Engineering and Management Research Page Number: 48-56

States’ Share in Central Taxes

Dr. Priyanka Banerji (PhD, NET, M.Com, PGDBA, PGDCA), Dehradun, INDIA

ABSTRACT function of Finance Commission is to make India is a large country with a variety of fiscal and recommendations regarding the following: regional development programmes which are introduced time (i) The distribution of net proceeds of taxes that are to time to promote regional equity and spatial development. ‘to be’ or ‘may be’ shared between the Union and the In federal fiscal set-up, resources are generally assigned more States and the allocation of shares of such proceeds to the Central Government on grounds of both equity and amongst the States. efficiency whereas States together with the local governments have the larger responsibilities. Therefore, ‘the Centre–State(ii) The principles which should govern the payment by the relations are crucial to the preservation of the unity and Union of grants-in-aid to the revenues of the States. integrity of India within the framework of its linguistic, (iii) Any other matter covering financial relations between the cultural and other dimensions’. Union and the States. The main thrust of development strategy has to The appointment of Finance Commission is focus on regional policies and the mechanisms of financial hence, of great importance for minimizing the vertical as transfers so that lagging States are provided fiscal resources well as horizontal fiscal imbalances between the Centre as per their fiscal needs. In view of the noteworthy fiscal and the States and amongst the States respectively. devolution and transfers have significant implications for Share of Centre and States in Revenue Receipts of various balanced regional development in India in an environment of economic reforms and globalization. Central transfers Finance Commissions is given in Table 1.1. The share of constitute a significant part of State finances. States in total transfers as percentage of revenue receipts peaked in the period of Ninth Finance Commission at Keywords---- Center-State Relations, Planning slightly above 39 per cent of Centre’s gross revenue Commission, Finance Commission, Union of grants-in-aid, receipts. In case of the Twelfth Finance Commission, the Tax Sharing, Centre to the States vis-à-vis Income Tax and total transfers have gone up again crossing 40 per cent. Union Excise Duties Table also shows that there is a progressive increase in the share of States in total revenue receipts over the period however, the corresponding share of the States in the combined revenue and total expenditures do not show a I. STATES’ SHARE IN CENTRAL similar increasing pattern.

TAXES

In federal fiscal set-up, resources are generally assigned more to the Central Government on grounds of both equity and efficiency whereas States together with the local governments have the larger responsibilities. Therefore, ‘the Centre–State relations are crucial to the preservation of the unity and integrity of India within the framework of its linguistic, cultural and other dimensions’. For this purpose, Finance Commission is appointed by the President, under the provisions of Article 280 of the Constitution, for the specific purpose of devolution of non-plan revenue resources. Hence, the 48 Copyright © 2011-15. Vandana Publications. All Rights Reserved. www.ijemr.net ISSN (ONLINE): 2250-0758, ISSN (PRINT): 2394-6962

Share of States of total transfers is shown in Table 1.2. The share of southern States in total transfers has fallen down from 27.86 per cent in Third Finance Commission to 18.36 per cent in Twelfth Finance Commission. Similarly, there is a declining trend in the In India, there is a wide disparity in the share of higher income States however, lower income devolution of taxes from Centre to States. Tax devolution States have gained from the fiscal transfers by the Finance has a built in flexibility as it can increase automatically if Commissions. The share of lower income States was the Central taxes are more buoyant and States have also reported 45.87 per cent during Third Finance Commission. expressed a preference for devolution because by It increased to 56.43 per cent in Twelfth Finance definition, it is unconditional and comes to the States as a Commission. Similarly, the share of special category matter of right. States also increased from 6.25 per cent in Third Finance This paper deals with the recommendations of the Commission to 15.97 per cent in Ninth Finance various Finance Commissions regarding the two major Commission. sources of revenue from the Centre to the States vis-à-vis Income Tax and Union Excise Duties. Whereas the sharing of the former is compulsory, the constitutional distribution of the latter is optional. To examine the inter-state disparities, ‘Thiele-T statistics method’ has been used with the help of the following formula:

II. DETERMINING SHARES OF STATES

Up till the Seventh Finance Commission, the formula used for determining the shares of income tax was 49 Copyright © 2011-15. Vandana Publications. All Rights Reserved. www.ijemr.net ISSN (ONLINE): 2250-0758, ISSN (PRINT): 2394-6962 clearly distinct from those of Union Excise Duties. Table 1.3: Distribution of Net Proceeds of Income Tax Population and collection/assessment were the only two under the Recommendations of Various Finance criteria used for determining the inter-se shares of the Commissions states in the case of income tax up to the Seventh Finance Commission. In respect of Union Excise Duty the criteria placed greater emphasis on factors relating to economic backwardness with fiscal weakness of the States. It was with the beginning with the Eighth Finance Commission two changes occurred. First, there was a move towards unifying the formulae for the inter-se distribution of both income tax and union excise duty. Secondly, a portion of the union excise duty was kept aside for distribution according to assessed deficits of States after the devolution of central taxes. This practice was continued by the Ninth and Tenth Finance Commission. However, the Eleventh Finance Commission in the interest of transparency had decided to discontinue the practice of keeping any portion of shareable taxes separately for distribution among the States with assessed deficits. Therefore, Thiele-T statistics has been used upto Tenth Finance Commissions separately to examine the behavior of inter-state disparities regarding income tax and union excise duty. 1. An Analysis of States’ in Income Tax Proceeds From Table 1.3, it is obvious that the States’ share in the divisible income tax has increased steadily from about 55 per cent, as recommended by First Finance Commission to 85 per cent under the Seventh, Eighth and Ninth Finance Commissions. However, this share has been reduced to 77.5 per cent under the Tenth Finance Commission.

Further from Table 1.3, it is also obvious that the First, Third and Fourth Finance Commissions have been given greater Weightage to tax collection, i.e. 20 per cent and 80 per cent to population. Hence, States like Maharashtra, West Bengal, Punjab, Gujarat and Tamil Nadu are the gainers. However, in the Second, Fifth, Sixth and Seventh Finance Commissions, population criterion has been given a higher weightage, i.e. 90 per cent over tax collection which was kept low at 10 per cent. Hence, more populous and backward States like Uttar Pradesh, Madhya Pradesh, Bihar, Orissa, Andhra Pradesh, Assam, Karnataka, Kerala, and Rajasthan are the gainers. However, these gains were not proportionate to their backwardness (Table 1.4). It is in place to mention that the weightage given to tax contribution got stabilized at 10 per cent since the Fifth Finance Commission.

Table 1.4: States’ Share in Income Tax as compared to all previous Commissions. This is because Recommended by four new States namely, Himachal Pradesh, Manipur, Finance Commissions Meghalaya and Tripura have been included in the divisible pool. Since, these States are small States, their respective shares are too low (0.60%, 0.18% and 0.27% respectively), hence the disparities have widened because there was no way to increase the total share either by the way of revenue equalization or through separate quota devolution (Table 1.4). Under the Seventh Finance Commission, Sikkim was the only State which was newly included with its low share at 0.035 per cent, hence, the disparities widened, but only marginally by 1 per cent (Table 1.5). As it is evident from Table 1.3, for the first time a new formula for the distribution of tax proceeds amongst States is adopted by the Eighth Finance Commission. It introduced two new criterions and hence the lower per capita income States like Bihar, Uttar Pradesh, Orissa, Madhya Pradesh, Meghalaya, Assam (at 1988-89 prices) have received larger shares. On the other hand, States like Maharashtra, Gujarat, Punjab, and Haryana have lost their shares in the divisible pool. Hence, the disparities increased further (Table 1.4). Under the Ninth Finance Commission, inclusion of three new States, Arunachal Pradesh (0.073%), Goa (0.110%) and Mizoram (0.073%) and the new criterion have tended to increase the disparities. Inspite of the new criterion have tended to increase the disparities. In spite of the new criterion under which 11.25 per cent weightage has been given to Composite Index of backwardness, there was no substantial change in the shares of States like Uttar Notes: @ included under Maharashtra, @@ included Pradesh, Madhya Pradesh, Bihar, Orissa and Rajasthan under Punjab, # includes Haryana & Chandigarh, (Table 1.4). *included under Union Territories, ** included under Our analysis thus, reflects that for the period Assam. covered by the Eighth, Ninth and Tenth Finance Source: Reserve Bank of India Bulletin, January-February, Commissions, there has been only a marginal change in 1996. the share of major backward States like Uttar Pradesh, Initially till the Fifth Finance Commission, the Madhya Pradesh, Bihar and Orissa. Therefore, we feel that disparities in the T-values have stabilized around 5 per the change in criteria is not going to benefit substantially cent (Table 1.5). The reason cited is that although more either the backward or the advanced State. Moreover, populous and backward states have received larger shares additional transfers of Income Tax share from Centre to but the other States are not far behind. the States are not feasible on account of resource constraint of the Union Government. Hence, Finance Commission should lay certain mandatory conditions for substantially improving tax and non-tax resources for the different State governments, particularly for the backward ones. 2. An Analysis of States’ Share in Union Excise Duties Proceeds It is necessary to emphasize that all the Finance Commissions kept the same goal of increasing States’ share in the Union Excise Duties, but, (i) First few Finance Commissions brought more and more commodities under the divisible pool whereas reduced the percentage share of the States (from 40 per In the Sixth Finance Commission, there is a cent dittoes to three commodities under the First Finance substantial increase in the disparities (Table 1.5) as

Commission to 20 per cent of duties on all commodities by Punjab and Haryana and Himachal Pradesh were one State, the Sixth Finance Commission). therefore, their relative shares were different; the backward From the Eighth Finance Commission onwards, States had more as compared to the advanced ones, but this the percentage share was steadily raised by successive difference was not too high. Hence, the disparities Commissions (from 40 per cent under the Seventh Finance remained low. Commission to 47.5 per cent under the Tenth Finance Commission) (Table 1.6).

Table 1.6: Distribution of Net Proceeds of Union Excise Duties under the Recommendations of Various Finance Commissions

However, there has been a substantial increase in the disparities from the Fourth to the Fifth Finance Commissions (Table 1.7). The share of States like Uttar Pradesh, Bihar and Madhya Pradesh has increased on account of higher weightage given to population and backwardness, while the advanced States such as Maharashtra, Punjab are the lowers. Hence the disparities increase (Table 1.8). As it is evident from Table 1.7 that during the Sixth Finance Commission, the disparities again widen. The reason behind this is that four new States were included whose respective shares were too low, Himachal Pradesh (0.63%), Manipur (0.21%), Meghalaya (0.19%) and Tripura (0.30%). However, the share of States like Uttar Pradesh, Madhya Pradesh, Bihar and Orissa declined on account of 5 per cent reduction on population criteria. The Seventh Finance Commission has given a new formula (Table 1.6) under which States like Uttar Pradesh, Madhya Pradesh, Bihar, Orissa, West Bengal all gained on account of weightage given to poverty ratio and inverse of per capita income and therefore, Maharashtra, Gujarat, Punjab and Karnataka were the losers (Table 1.8). It can be noticed from the Table 1.7 that the disparities have more or less stabilized from the Seventh to the Eighth Finance Commissions even though the latter introduced yet another formula. This is first time that 5 per cent devolution in the net proceeds of Union Excise Duties has been kept separately for the States that have deficits in spite of devolutions of taxes and duties and hence the disparities have almost remained same. It is also in place to mention that in the Fifth and Sixth Finance Commissions, Special Excise Duties and Auxiliary Excise Duties respectively are included. It is obvious from Table 1.7, from First to the Fourth Finance Commissions; the disparities have tended to be low, because a common criterion of distribution of States’ share on the basis of population and backwardness has been accepted by the above Finance Commissions. In addition to this, since many States were integrated into one example, Maharashtra and Gujarat were one and similarly 52 Copyright © 2011-15. Vandana Publications. All Rights Reserved. www.ijemr.net ISSN (ONLINE): 2250-0758, ISSN (PRINT): 2394-6962

Notes: @ included under Maharashtra, @@ included under Punjab, # includes Haryana & Chandigarh, *included under Union Territories, ** included under Assam. Source: Reserve Bank of India Bulletin, January-February, 1996. Under the Ninth Finance Commission, three new States like Arunachal Pradesh, Goa and Mizoram have been included which unlike the case of income tax, have tended to reduce the disparities. In addition of this, these States as well as the other deficit States also received some share in the 5 per cent devolution of Union Excise Duties. However, on the other hand, States like Uttar Pradesh, Madhya Pradesh, Bihar, Maharashtra, West Bengal, Tamil Nadu, Karnataka, Gujarat and Andhra Pradesh have lost their respective shares as they did not receive any part in the 5 per cent devolution. Finally under the Tenth Finance Commission, the disparities widened because of new criteria giving 20 per cent weightage to tax effort, infrastructure and area adjusted taken together (Table 1.6). The States like Maharashtra, West Bengal, Karnataka have increased their shares on account of weightage given to tax effort; States like Uttar Pradesh, Bihar and Rajasthan have also gained as they have received some share in 7.5 per cent devolution of Union Excise Duties kept for deficit States and similarly, Punjab, Rajasthan, West Bengal, Gujarat have gained on account of weightage given to area adjusted. On the other hand, in spite of receiving major share in the 7.5 per cent devolution, Andhra Pradesh, Assam, Manipur, Meghalaya, Jammu & Kashmir, Himachal Pradesh, Orissa, Tripura and Sikkim have lost their respective shares under the Tenth Finance Commission and the reason can be attributed to the new criterion adopted. The Eleventh Finance Commission focused to review the State of finances of the Union and the States and suggest ways and means by which the governments may bring about a restructuring of the public finances restoring budgetary balances and maintain micro-economic stability and debt reduction along with equitable growth.

The high income Gujarat, Haryana and Maharashtra, Punjab and Goa and the middle income Andhra Pradesh, Karnataka, Kerala, Tamil Nadu and West Bengal have thus been bracketed with the rest and treated as low income ones based on their contribution to the Gross State Domestic Product (GSDP). The middle income States have suffered a marginal decline in share of tax devolution because of a sharp increase in share of West Bengal from 7.471 per cent to 8.116 per cent concealing the shares of four middle income southern States (Tables 5.5 and 5.12). Andhra Pradesh share of the divisible pool has come down from 8.465 per cent in Tenth Finance Commission to 7.701 per cent in Eleventh Finance Commission despite improvement in tax performance and Note : Expenditure tax and service tax are not presently index of fiscal self-reliance. Bihar, Madhya Pradesh and leviable in the State of Jammu & Kashmir. Therefore, Uttar Pradesh have gained on the basis of income distance share of Jammu & Kashmir in net proceeds of these taxes criterion. It is in place to mention that further the States is not assigned to this State. from the benchmark of average per capita the more points Source: Report of Eleventh Finance Commission, Chapter it receives. Since Kerala rapidly shot up in such ranking of VI. States, it received fewer points. However, during the last three Finance We feel that now, Finance Commission has a Commissions, the Eighth, Ninth and the Tenth the inter- critical role to play, as how much can a Finance state disparities have tended to stabilize for middle income Commission provide to the backward States, if they states. This gives a clear indication that, although these continue to face sustained deficits in their revenue account. Finance Commissions have tried to benefit the backward In the case of high income states, there has been States, but there was no major change in the share of Uttar decline in their shares from the divisible pool (Table 1.9). Pradesh, Madhya Pradesh, Bihar, and Orissa. Hence, Hence, it can be concluded that there has been an increase changing the criteria of distribution of net proceeds will in the shares of backward States such as Uttar Pradesh, not bring significant changes in the share of various States Madhya Pradesh, Bihar, and Orissa over the developed especially the backward ones. states in the divisible pool of both income tax and union The criterion for devolution of taxes in percentage excise duties. under Twelfth Finance Commission was:

The total share of States in the total sharable Central taxes was fixed at 30.5 per cent and the share of States to come down to 29.5 per cent if the States levied sales tax on sugar, textiles and tobacco. The poor States such as Orissa, Chhattisgarh, Jharkhand and the relatively well-off ones like Andhra Pradesh, Karnataka, Kerala and Tamil Nadu have been allocated less than what was recommended by the Twelfth

Finance Commission. West Bengal, which was placed at a considerable disadvantage by the Twelfth Finance Underplaying poverty on the one hand and giving Commission (has been only partially compensated by the increased weightage to fiscal discipline on the other have Thirteenth Finance Commission). But it is still facing a placed the poorer states at a disadvantage. They are likely loss by more than eight per cent, compared to the Eleventh to face higher losses. This award will make the task of Finance Commission. reducing existing regional inequalities more difficult. The Commission also noted that, relative to FC- Rather it may enhance the inequalities. This has been XII, there is an increase in the ratio of devolution to GSDP noticed in the past. Rich States tend to attract more (as projected by us) for each State (Table 1.12). Thus, investments from abroad. This increases their growth every State has, taken individually, gains in terms of momentum, while the poor remain deprived of this benefit. devolution relative to its GSDP. Now that poorer States will receive less money from the Central Taxes, the aspirations of the people will remain unfulfilled.

III. CONCLUSION

Finally, on account of our analysis, we think that the short-term solution to overcome revenue shortfalls of the different States, particularly backward States, is by providing larger shares to these States. This can be done either by squeezing a little more from the Centre’s share or by making some provision of about 5 per cent in the devolution of States’ share in the divisible income tax, for the deficit States (same as that provided in the devolution of shareable Union Excise Duties). This would act as an incentive for the backward States to improve their revenue position in the long-run.

IV. RECOMMENDATIONS

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