Friction of Revenue Sharing Formula


Friction of Revenue Sharing Formula

News: Critics argue that the 15th Finance Commission formula is skewed in favour of some states, resulting in wide inter-state variations.

How are Taxes distributed among states?

→ The Centre collects taxes from states and distributes it among them based on the Finance Commission's (XVFC) formula.

→ The XVFC formula is based on each state's needs (population, area and forest and ecology), equity (percapita  income difference), and performance (own tax revenue and lower fertility rate).

→ Needs are given 40% weightage, equity 45%, and performance 15%.

→ The XVFC introduced the fertility rate component to reward states that have reduced fertility levels, but this has a lower weightage than equity and needs.

What are issues in XVFC formula?

→ The XVFC formula is skewed in favour of some States, resulting in wide inter-State variations. For example, for every one rupee that Tamil Nadu gives the Centre, it gets back 29 paise while (UP gets ₹2.73 and Bihar gets back ₹7.06)

→ Critics argue that this formula favours some northern states, as the population is given higher weightage. (Rewarding those who have not been able to achieve population control)

→ While the developed States that have lowered their TFR below replacement rate benefit from the drop in TFR, the component’s weight is considerably less.

What do those defending the formula say?

→ The objective of the transfer of funds is to enable a State to provide comparable levels of services.

→ The basic rationale is horizontal equity.

→ However, others contend that the formula should not adversely impact a state's efficiency and progress.

Way Forward

The new fiscal federal architecture must be developed via forums like the GST Council, Inter-state Council, and NITI Aayog to accommodate the specific needs and aspirations of states as the dynamics of fiscal federalism change in India.

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