The Centre will continue sharing 41% of its tax revenue with the states. This has been the same percentage share since the last Commission and gives the impression that the fiscal relationship between Delhi and the states will remain unchanged.
But this does not reflect the real issue.
In India’s federal system, the question is not how much the states receive cumulatively. The real question is how the funds are distributed among the states and what that distribution indicates about the balance of power.
Where the real fight begins
The Finance Commission has always been described as an independent authority stemming from the Constitution and is supposed to ensure that transfer arrangements will be based on a formula.
However, formulas are never really independent.
When making calculations, each of these elements is used in some respectful way to assess what is most important about the formula. And thus, these decisions are made during each Commission process.
The 16th Finance Commission has continued down this path, but the emphasis has shifted slightly.
Historically, the basis of transfer distributions has been the same. Transfers to poorer states are greater, and transfers to wealthier states are smaller. The logic of redistribution has been clear: the need for simultaneous growth and for reducing inequality through transfers to poorer states.
The way this logic works is now being changed to incorporate the use of up-to-date population data and using GDP contribution for the nation in total. This means that while the Commission is not entirely abandoning redistribution, nor is it solely using redistribution anymore.
The use of performance metrics is being added to the calculation as well.
This has created a debate that has moved beyond being solely technical.
A debate that is no longer technical
The states in the southern and western regions of India (where the economies are stronger with more tax contribution, and the population is growing more steadily) have consistently argued that the current formula has penalised their economic efficiency, leading to a sense that in addition to being penalised; the system has created a permanent outflow of transferred income through redistribution.
On the opposite side, there are the states which have been highly dependent on transfers from the Centre for their survival. For them, the idea of reducing redistributive transfers creates fear for economic reasons but also for political reasons because of the fear of increased inequality and development disparities throughout India as a result.
Both sides are correct, but from different perspectives is the reality that makes today’s argument much more difficult than any prior time.
Today’s argument has created more than a technical formula; It represents the two representations for the vision of India.
The lesser discussed shift in forward movement
This conversation covers part of the broader shift taking place. The more significant change in India’s fiscal federalism is occurring outside of the Finance Commission.
The Union government has been increasingly relying on cesses and surcharges for many years now. These are taxes not being divided among the states so that they do not receive a share of them. Likewise, there have been an increasing number of centrally-sponsored schemes linking funds to specific conditions.
The end result is that the system appears to be federal on the surface, but the reality is that it is becoming more centralised in practice.
While states continue to receive their tax revenues, the public spending portion is being more frequently shaped, directed, and sometimes controlled by the Centre.
After GST, a tighter fiscal space
The introduction of GST has further contributed to this shift.
GST has created a unified national market, but it has done so at an expense. Prior to GST, states could raise revenue independently of the GST, but because of the implementation of GST, the current tax systems have become more integrated and dependent on the shared decision-making process.
States are limited in terms of spending due to reductions in compensation agreements and disputes over revenue distribution.
With this in mind, the Finance Commission’s new responsibilities are increasingly important — and increasingly controversial.
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More than a formula
The work of the Finance Commission does not include only distributing monetary allocations.
It is defining a new federal framework for India.
What is a fair level of redistribution?
What is the appropriate level of reward for performance?
What level of authority should the Centre have?
These are not simply technical issues; they are political decisions producing economic results.
A system under strain
India’s fiscal federalism was created to accommodate the great diversity in the country, namely, diversity of economics, population, and regions.
However, as these types of divisions become more pronounced, the fiscal federalism system has begun to strain.
The old fiscal federalism model, which relied exclusively on redistributing federal funds, is being modified and transitioned into a new model that includes a combination of redistribution and performance as well as heavy levels of centralized control.
The extent to which this new model (a blend of the old and the new) can maintain balance will influence more than just how resources are shared, but how power is distributed in the Union.
Fiscal federalism, therefore, is not solely a financial matter; it is about who will make decisions regarding future economic development in the country and who will not.
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