Introduction
The Chief Minister of Madhya Pradesh recently proposed an increase in the states’ share in central taxes from 41% to 48% to the 16th Finance Commission. This recommendation has sparked debates about fiscal federalism, revenue allocation, and financial autonomy of states. But what does this proposal mean for India’s economic structure?
Understanding the Tax Distribution Mechanism
Under Article 280 of the Indian Constitution, the Finance Commission is responsible for recommending tax revenue sharing between the Centre and the states. The 15th Finance Commission had fixed the states’ share at 41% (from the divisible pool of taxes) for the 2021-26 period.
The key sources of revenue in the divisible pool include:
- Income Tax
- Corporate Tax
- GST (excluding cess and surcharge)
- Customs Duties
- Excise Duties
State governments argue that increasing their share in the divisible tax pool would help them fund welfare schemes, infrastructure projects, and social initiatives without being overly dependent on central grants.
Arguments for Increasing the States’ Share
- Greater Financial Autonomy – Higher revenue allocation allows states to better address local economic needs and developmental priorities.
- Rising Financial Burden – States bear increasing responsibilities in healthcare, education, and rural development, especially after pandemic-driven fiscal pressures.
- Federalism & Decentralization – More funds to states align with cooperative federalism, allowing decentralized decision-making.
- Reduction in Centrally Sponsored Schemes (CSS) – If states receive more untied funds, their reliance on centrally-sponsored projects will decrease, providing them with greater control over expenditures.
Challenges & Counterarguments
- Impact on Central Expenditure – A higher share for states means the Centre will have fewer resources to fund national programs like defense, national highways, and subsidies.
- Uneven Fiscal Capacity – States vary in their revenue-generating capacities. Will a uniform share benefit economically weaker states more than prosperous ones?
- Accountability & Fiscal Prudence – Higher allocations must come with fiscal responsibility mechanisms to prevent inefficient spending.
Legal & Policy Framework: What Supreme Court & RBI Say
Supreme Court Observations on Fiscal Federalism
The Supreme Court has often reiterated that federalism is part of the Constitution’s basic structure. Cases such as:
- State of West Bengal v. Union of India (1963) – Affirmed states’ rights to revenue autonomy.
- SR Bommai v. Union of India (1994) – Strengthened fiscal decentralization principles.
RBI’s View on State Finances
The RBI’s State Finance Report (2024) highlighted growing fiscal stress among states, urging better revenue-sharing mechanisms to balance growth and debt management.
International Comparison: How Other Countries Handle Revenue Sharing
- United States: States collect their own taxes, with federal grants supplementing revenues.
- Germany: A cooperative model ensures a balanced fund distribution between states and federal government.
- Brazil: A revenue-sharing system ensures redistribution from richer to poorer states, reducing regional disparities.
India can draw lessons from these models to create an equitable and growth-driven revenue-sharing framework.
Conclusion: A Balanced Approach Needed
The demand for increasing states’ share in central taxes to 48% is a significant policy shift that requires a balanced approach. A structured review of revenue-sharing models, legal precedents, and economic impacts is crucial before making any decision.
A hybrid model, where revenue-sharing is complemented by performance-linked incentives, could be an optimal solution. This would ensure that states receive adequate funds while maintaining fiscal discipline.
As the 16th Finance Commission deliberates on this issue, the future of India’s fiscal federalism remains at the center of economic policy discussions.