Towards a more federal structure

What is the issue?

India’s choice of a Union, instead of a federal set up, post-independence has had the effect of making states more dependent on the Centre.
It calls for a rethink, especially given the financial challenges posed by this form.

How does revenue distribution work?

Direct taxes include income tax and corporate tax.
In the U.S., both the federal and State governments collect such taxes from individuals and corporations.
The federal government distributes about 15% of its revenues.
Unlike this, in India, direct taxes go entirely to the Central government.
The Central government is then supposed to distribute 41% of its gross tax revenues to the State governments.

What are the concerns?

State governments get funds from the Central government according to the Finance Commission’s recommendations, based on some formula.
But often politics intervenes and some States get less and some more.
Usually the Central government does not meet the 41% target.
Meanwhile, the Central government has added cess on various items.
This adds up to over Rs.3.5 lakh crore.
This (cess) is not shared with the State governments.

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 makes them even more dependent and gives more economic power to the Central government.

How is regional disparity reflected?

Maharashtra, Delhi and Karnataka contribute the major share of taxes to the government.
These three regions along with Tamil Nadu and Gujarat contribute 72% of the tax revenue.
Uttar Pradesh, which has the largest population in India, contributes only 3.12%.
But, it gets over 17% of the revenue distributed by the Central government.
Revenue distribution is based on complex considerations including population and poverty levels.
For every Rs.100 contributed, southern States get about 51% from the Central government, whereas Bihar gets about 200%.
The population growth rates in the south have come down to near zero.
On the other hand, population continues to grow in central and north India.
So, the cross subsidy from the south to the north will continue to grow.

What is the way forward?

Making the fund allocation fairer is almost impossible because of politics.
So, looking beyond the current framework is pertinent.
One step could be to provide greater economic power to the States.
With this, they can directly collect more taxes and be less dependent on the Central government.
For poorer States, a period of transition is perhaps required.
In all, a transition to a more federal structure would improve Centre-State relations.

Source: The Hindu