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Tags Current Affairs

Finance commission recommendations

Date: 04 February 2020 Tags: Constitution

Issue

The Fifteenth Finance Commission (FC) has considered the 2011 population along with forest cover, tax effort, area of the state and demographic performance to arrive at the states’ share in the divisible pool of taxes.

 

Background

The Finance Commission is a constitutionally mandated body that decides, among other things, the sharing of taxes between the Centre and the states.

 

Details

  • Article 280 (1) requires the President to constitute an FC which shall consist of a Chairman and four other members.

  • The Commission determines a formula for tax-sharing between the states, which is a weighted sum of the states’ population, area, forest cover, tax capacity, tax effort and demographic performance, with the weights expressed in percentages.

  • Commission report

  • The Commission has reduced the vertical devolution, the share of tax revenues that the Centre shares with the states, from 42% to 41%.

  • The 1 per cent decrease in the vertical devolution is roughly equal to the share of the erstwhile state of Jammu and Kashmir, which would have been 0.85% as per the formula described by the Commission.

  • The Commission intends to set up an expert group to initiate a non-lapsable fund for defence expenditure. The terms of reference of the Commission included considering the Centre’s demand for funds for defence and national security.

  • The previous FC used both the 1971 and the 2011 populations to calculate the states’ shares, giving greater weight to the 1971 population (17.5%) as compared to the 2011 population (10%). 

  • The use of 2011 population figures has resulted in states with larger populations like Uttar Pradesh and Bihar getting larger shares, while smaller states with lower fertility have lost out.

  • The combined population of the Hindi-speaking northern states (Bihar, Uttar Pradesh, Madhya Pradesh, Rajasthan and Jharkhand) is 47.8 crore. This is over 39.48% of India’s total population, and is spread over 32.4% of the country’s area, as per the 2011 Census. They also get a slightly more than the proportional share of the divisible pool of taxes (45.17%).

  • On the other hand, the southern states of Tamil Nadu, Kerala, Karnataka and undivided Andhra Pradesh are home to only 20.75% of the population living in 19.34% of the area, with a 13.89% share of the taxes.

  • In order to reward population control efforts by states, the Commission developed a criterion for demographic effort , which is essentially the ratio of the state’s population in 1971 to its fertility rate in 2011, with a weight of 12.5%.

  • The effect of the demographic effort in increasing states’ devolution is not clear. Shares of states like Maharashtra, Himachal Pradesh and Punjab, along with Tamil Nadu, all of which have fertility rates below the replacement level, have increased slightly. On the other hand, Andhra Pradesh, Kerala, Karnataka, and West Bengal’s shares have fallen, even though their fertility rates are also low. The weight assigned to state area was unchanged at 15%, and that of forest cover was increased from 7.5% to 10%.

  • The total area of states, area under forest cover, and “income distance” were also used by the FC to arrive at the tax-sharing formula.

  • Income distance is calculated as the difference between the per capita gross state domestic product (GSDP) of the state from that of the state with the highest per capita GSDP, with states with less income getting a higher share in order to allow them to provide services comparable to those provided by the richer ones.

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