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Economy
Mahesh

23/01/24 07:17 AM IST

Tax contribution by States needs to be revisited

In News
  • The Finance Commission’s important job is to recommend a distribution formula specifying each State’s share in the part of the Union tax revenue assigned to States.
Finance commission
  • Two important tasks of the Finance Commissions are (i) to recommend the proportion of the Union tax revenues to be assigned to States and (ii) to recommend the share of each State in the assigned tax revenue.
  • Till 2000, that is, the 10th Finance Commission, the States’ share was restricted only to personal income tax and Union excise duties and after that, all the Central tax revenues were pooled, and States’ shares were decided.
  • With reference to the second task, the Finance Commission devises a distribution formula to arrive at a share for each State, and it is based on the principles of equity and efficiency.
  • Equity stipulates that the revenue-scarce States and States with higher expenditures get larger shares of Union tax revenue than others.
  • Efficiency is to reward the States that are efficient in collecting revenue and rationalising spending.
  • The trade-off between equity and efficiency is normative and remains dynamic in successive Finance Commission recommendations.
Issues
  • Successive Finance Commissions have assigned 10% to 20% weight to income tax revenue collection/assessment in the distribution formula for income tax revenue because collection is not a good indicator of contribution.
  • In the case of Union excise duties, the value of taxable products consumed in a State is essential to decide its contribution.
  • Due to the unavailability of proper consumption statistics, contribution was never a determinant in the distribution formula for Union excise duties.
  • Population, a chief indicator of the expenditure needs of the State, was given 80% to 90% weight in the first seven Finance Commissions as far as income tax distribution was concerned.
  • In the case of distributing revenue from Union excise duties, the entire distribution was based on population or other indicators of expenditure needs such as area, per capita income, proportion of Scheduled Caste/Scheduled Tribe population, and some indicators of social and physical infrastructure needs.
  • Since the 10th Finance Commission, the Commission has recommended a single distribution formula for both income tax and Union excise duties. Thus, the Finance Commissions have always favoured assigning more than 75% weight to equity indicators.
Formula for tax distribution
  • Since 2000, the formula for the distribution of pooled Central tax revenues included tax effort and fiscal discipline as efficiency indicators with a weight of around 15%.
  • Tax effort is broadly defined as the ratio of own revenue of a State to its Gross Domestic Product.
  • Fiscal discipline is the proportion of own revenue to the revenue expenditure of a State.
  • In the 15th Finance Commission, the distribution formula had tax effort with a weight of 2.5%, and demographic performance, an indicator of efficiency in population control, was given a weight of 12.5%.
  • The remaining 85% weight was distributed among equity indicators of per capita income, population as per the 2011 Census instead of the conventional 1971 Census, area, forest cover, etc.
GST
  • GST is a consumption-based destination tax that is equally divided between the State and Central governments.
  • In other words, the State GST accrual (inclusive of Integrated GST settlement) to a State should be the same as the Central GST accrual to the Union government from that State.
  • Therefore, accurately estimating the tax contribution from a State to the Union exchequer is feasible under GST.
  • The absolute amount of GST revenue generated from each State would differ by the size and structure of States’ economies, and this marks the importance of the inclusion of this tax contribution as an efficiency indicator in the distribution formula.
  • A State’s GST contribution is not affected by discretionary tax policies of the State; it only reflects the accurate tax base of the State that is being exploited for the national good. 
  • In addition to GST, petroleum consumption is also an indicator of tax contribution to the national exchequer.
  • The Union excise duty and sales tax on petroleum products are outside GST.
  • The cascading tax burden of these two taxes in addition to the burden of customs duty on petroleum imports falls on the final consumers of petroleum products in a State.
  • Just like GST, the relative shares of petroleum consumption vary across States, but such shares are stable over time for every State.
  • Therefore, the relative share of a State’s petroleum consumption reflects the relative contribution of the State to the national exchequer in the category of Union excise duties and customs duties on petroleum products.
  • The share of CGST and Union excise duty is about 30% of States’ share in Central tax revenue in 2021-22 and the similar ratio for personal and corporate income taxes is 64%.
  • There is a persuasive case for the 16th Finance Commission, recently constituted by the Union government, to debate and include these ratios as a measure of efficiency with a weightage of at least 33% in the distribution formula.
Source- The Hindu

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