Recent years have seen growing tensions between the Union government and many state governments on the matter of the proper sharing of tax revenue.



Some of this has been caused by the transition to goods and services tax (GST), which has reduced the space available to state governments to raise their own revenue. This has been exacerbated by the end of the GST compensation payments.


Unequal tax distribution

  • It is essential that the guaranteed increases in state revenues under the GST bargain come to an end at some point so that states are incentivised to collect indirect taxes properly.
  • Yet the broader argument made by states, that the Union government is taking too large a share of the tax revenues, has some merit when examined against the data. 
  • The statesshare in taxes collected by the Union government has been range-bound between 29 and 32 per cent since the pandemic hit in 2020-21. This is about 10 percentage points lower than the recommendations of the Fifteenth Finance Commission.


The problem of cess and surcharges

  • At a recent meeting of the governing council of the NITI Aayog, the state governments indicated that their resources to fund spending were dwindling. Part of the responsibility for this situation lies with the Union government, which has developed an excessive dependence on various kinds of cess and surcharge in the tax mix. These, unlike regular taxes, do not have to be shared with the states, and are not part of the divisible pool.
  • The proportion of revenue raised from cess and surcharges has risen from about 6 per cent when the National Democratic Alliance government first took office in 2014 to almost a quarter of the tax collection now. This is due also to the decision to increase the taxes on fuel.


Why is it unfair to states?

  • The fact is that the statesadministrative machinery is in 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 tendency for fiscal and spending power to be accumulated in New Delhi through various measures such as cess or centrally sponsored schemes could affect the delivery of quality services to citizens.
  • Although the quality of spending in some states is being debated, the fact remains that state governments have the right to prioritise.


Way forward

  • It is understandable that the Centre also has spending commitments and needs resources to finance, for instance, national security needs and also run welfare programmes. However, the division of fiscal resources should be done more transparently.
  • The imposition of cess and surcharge also distorts the tax system and creates inefficiencies. Excessive dependence on cess and surcharge with the aim to corner more resources could increase resentment among states and lead to greater friction between the Centre and the states.
  • Since it is important in a country like India that the Union and state governments work together to take the development process forward, such potential points of friction should be avoided. In terms of spending, reforms are needed at both levels of the government.


SourceBusiness Standard


QUESTION – An important aspect of good governance is fair tax distribution among all levels of government. Briefly discuss how the tax distribution system between the centre and states can be made more transparent.