the disparity between resource mobilization by the Center and state governments persists

The 16th Finance Commission faces a daunting challenge as the disparity between resource mobilization by the Center and state governments persists. With a focus on sustainable development goals and balanced regional growth, the upcoming commission will decide the distribution pattern of net tax proceeds between the Center and states for the five-year period starting April 2026.

Examining past Finance Commission awards reveals that although states’ access to non-tied central funds increased under the 14th Finance Commission, the intended benefits were curtailed by FY20. The Center’s augmentation of non-shareable taxes through various fuel cesses, coupled with pandemic-induced economic slowdown, resulted in a 15.8% average annual growth in tax devolution to states during the 14th Finance Commission period.

Despite the states’ increased share in the divisible tax pool over the last nine years, there has been a comparative decline in the annual growth of tax devolution from the Center. Notably, the slowing pace of tax transfers occurred despite the Center exceeding gross revenue receipts in FY21-24, and public debt reduction outpacing the commission’s projections.

While the compensation mechanism provided a 14% annual growth in state-GST revenue, it led to a moderation in tax efforts by some states. Addressing complacency in tax revenue mobilization becomes a priority for the new commission.

The aftermath of the compensation is evident in states’ own tax revenues, which remain unsatisfactory after benefiting from the GST compensation mechanism. The share of cess and surcharge in the Union government’s gross tax revenue rose from 15% in the 14th Finance Commission to over 20% in FY21, moderating slightly thereafter.

Despite higher tax devolution rates, general-purpose transfers increased but were offset by the discontinuation of assistance from the abolished Planning Commission and adjustments in states’ shares in centrally sponsored schemes.

Demands from opposition-ruled states include integrating cesses and surcharges into the divisible pool of central taxes and increased central funding for centrally sponsored schemes. The horizontal distribution of shareable tax proceeds aimed at addressing equity issues has raised concerns about penalizing states with better development parameters.

States such as Kerala, Karnataka, and Tamil Nadu witnessed a decrease in their share in the tax pool, while richer states like Maharashtra and Punjab gained. Disparities in annual growth rates of grants in aid received from the Centre and reformist conditions for central grants distribution further contribute to the challenges faced by states, highlighting the need for a comprehensive approach by the 16th Finance Commission.