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Advising a formula to distribute the Union tax proceeds between Union and the States is the most important task of a FC, as the share of states in the net proceeds of Union taxes is the predominant channel of resource transfer from the Centre to states.
It is that portion of gross tax revenue which is distributed between the Centre and the States. The divisible pool consists of all taxes, except surcharges and cess levied for specific purpose, net of collection charges.
Before the 80th Constitution Amendment (2000), the sharing of the Union tax revenues with the states was in accordance with the provisions of articles 270 and 272, as they stood then. This amendment altered the pattern of sharing of Union taxes in a fundamental way—dropping the Article 272 and substantially changing the Article 270. The new Article 270 provides for sharing of all the taxes and duties referred to in the Union List putting all in a ‘divisible pool’. There are some exceptions to it. The taxes and duties referred in the Articles 268 and 269 of the Constitution, together with
surcharges and cesses on taxes and duties (referred in the Article 271) and any cess levied for specific purposes—do not fall under this ‘pool’.
The new arrangement of tax devolution came as a follow-up to the recommendations of the 10th FC (1995–2000) which the FC termed as the ‘Alternative Method of Tax Devolution’ (AMD). A concensus between Union and States was a advised by the FC for such an arragnement to be effected. States were going to get extra 5 per cent share in the Union taxes in the AMD, thus, a serious demand came from them—ultimately, the AMD was accepted by the Centre. To make the AMD irreversible, the Goverment of India went for the 80th Amendment in the Constituion.
Though, tax devolution (from the Divisible Pool) is the primary instrument to attend the issue of ‘horizontal imbalances’ of revenue accruing to the states, the grants-in-aid is a complimentary/secondary instrument regarding the same. As per the Article 275, the FC recommends the principles as well as the quantum of grants to those states which are in need of assistance – different sums may be fixed for different states (one of the pre-requisites for such grants is the assessment of the needs of the states). The 1st FC had laid down five broad principles for determining the eligibility of a state for grants:
(i) The Budget of a state as the starting point for examination of a need.
(ii) The efforts made by states to realize the potential.
(iii) The grants should help in equalizing the standards of basic services across states.
(iv) Any special burden or obligations of national concern, though within the state’s sphere, should also be taken into account.
(v) Grants might be given to further any beneficent service of national interest to less advanced states.
The grants recommended by FC are predominantly in the nature of general purpose grants meeting the difference between the assessed expenditure on the non-plan revenue account of each state and the projected revenue including the share of a state in Central taxes. These are often referred to as ‘gap filling grants’.
The scope of grants to states, over the yaer, was extended further to cover special problems. Following the 73rd and 74th Amendments to the Constitution, FCs were charged with the additional responsibility of recommending measures to augment the Consolidated Fund of a State to supplement the resources of local bodies. This has resulted in further expansion in the scope of FC grants. The 10th FC was the first Commission to recommend grants for rural and urban local bodies. This way, the scope of grants-in-aid has gone for considerable extension, over the time.
The fiscal capacity (also called ‘income distance’) criterion was first used by the 12th FC, measured by per capita GSDP as a proxy for the distance between states in tax capacity. When so proxied, the procedure implicitly applies a single average tax-to-GSDP ratio to determine fiscal capacity distance between states. The 13th FC changed the formula slightly and recommended the use of ‘separate averages’ for measuring tax capacity, one for general category states (GCS) and another for special category states (SCS).
This as a criterion for tax devolution was used by the 11th and 12th FCs to provide an incentive to states managing their finances prudently. The criterion was continued in the 13th FC also. The index of fiscal discipline is arrived at by comparing improvements in the ratio of own revenue receipts of a state to its total revenue expenditure relative to the corresponding average across all states in the country.
While the 12th FC (2005–10) was being set up, the GoI decided to make the Planning Commission (PC) function as a ‘collaborator’ to the FC—one member of the PC was added as an ‘additional member’ on the panel of the FC (the FC includes four members including the Chairman)—as a link between the bodies. This arrangement was continued with in the 13th and 14
FCs. It is believed that this arrangement was greatly helpful in bringing in a better idea about the revenue imbalances of the states. While the government did set up the NITI Aayog, no announcement came in this regard – there might be some developments in this regard once the 15th FC (2020–25) is set up in future.