Under its modified criterion, the 15^th Financial Commission has proposed two additions in addition to quintessential, marginal change in population and forest cover criteria. Consequently, the newly inducted parameters are demographic performance (higher weightage for lower fertility rate states) and tax effort.

As a result of these additions, the Commission is apparently trying to incentivize states towards mobilization of own-tax revenue more effectively. We note that recently, farm-loan waivers[1] and income support[2] schemes have evolved as a primary priority for state governments. During FY15 to FY20, states have announced around 2.7 lakh crore as farm-loan waiver. In FY20, this program bears around 1.2% state governments’ total expenditure. Furthermore, income-support schemes such as Rythu Bandhu scheme in Telengana and Parivar Samman Nidhi in Haryana are an additional burden on the exchequer. Such expenditures not only reduces allocation for critical developmental activities but also deviate from the all-important fiscal target. Moreover, higher share of state on Centre’s gross tax will lower the fire power of the central government, especially while creating infrastructure and defence assets necessary during at this time. During the Covid-19 crises, we have noted the deficiencies caused by non-necessary fiscal obligations, which were budgeted earlier in both central and state estimates. Even post such allocations, utilization levels for disaster management related funds is woefully inadequate among certain states.

From the tax revenue view point, the coming years will be more challenging. Case in point being the recent incentive for domestic corporates will reduce corporate tax collection and the lower GST collection on the back of Covid-19 related lockdown. In addition, weak growth in imports will reduce revenue collection under custom duties. The depreciation of domestic currency has already increased the import cost for domestic companies, leaving limited scope for higher duties on imported goods. This can be nonetheless offset by the lower oil prices to some extent.

It is therefore recommended that states should increase their tax base to increase their revenue receipts. The situation appears to be grave given the fact that recent trend shows the own-tax revenue to GSDP of the states is almost stable. During FY15 to FY17, the own-tax revenue to GSDP stands at just 6.2%. The share increased to 6.7% between FY18 and FY20. However, the increase in share during the recent three years is due to implementation of GST, due to which certain states (primarily consumption states) got a higher share in the GST pool at the cost of producer states.

GST has been carved out from other tax categories as well and reflects under own-tax revenue heads. Therefore, overall, the state’s own tax revenue to GSDP remains stable. We further believe that states should increase efficiency of state-owned entities in order to get higher non-tax revenue such as dividend and profit. A development that can potentially rationalize the tax collection from fees and user charges, that otherwise under-potential.

 Criteria for tax devolution:

Tax to GDP ratio:

Note: # indicates share of own-tax revenue to GSDP increased as subsume of tax changed after implementation of GST. States considered here are only non-special category.