ARE INCOME DISTANCE CRITERION AND DEMOGRAPHIC PERFORMANCE CRITERION SUSTAINABLE FOR STATE TAX DEVOLUTION?: SOWJANYA S

 

Introduction- Article 280 of the Constitution of India deals with the Finance Commission. It states “The president shall… by order constitute a Finance Commission which shall consist of a Chairman and four other members to be appointed by the President”.  Article 280(2) of the Constitution provides a list of functions as duties of the Finance Commission. This list includes- Distribution of Net Proceeds of Taxes between the Union and the States, principles governing grants in aid, any other matter referred to the Commission by the President in the interests if sound finance. There emerge two concepts, the vertical and the horizontal devolution. The Union Government collects most of the tax proceeds, and the State government does the executive work. This is called Vertical Devolution. The ratio in which the states divide up their shares is the Horizontal devolution.

 

The Fifteenth Finance Commission- The 15^th Finance Commission was constituted in November 2017 by the President for providing recommendations to the president on devolution of taxes and other principles on financial matters for the five financial years commencing from 1^st April 2020[1]. The Commission has to submit two reports. The first report of recommendations is for the Financial Year 20-21 and the final report consisting of the recommendations for the financial years 2021- 2026. The interim report (first report) was tabled by the Finance Minister on 01^st February 2020. 

 

The Interim Report (2020- 2021)- Generally, there will be few criteria’s in which the devolution of tax happens in every financial report. The indicators might vary from report to report based on the contemporary and predicted economic conditions. For example, the 14^th Financial Commission report used the Income Distance criterion as the substantial indicator for the devolution. The same had been followed by the 15^th Finance Commission. The 15^th Commission also introduced a new criterion- the Demographic Performance criterion to be used with the Income Distance criterion.

 

The Specified Criterions- The interim report though had 7 criterions in totality including; Income Distance, Population (2011), Area, Forest Cover, Forest ecology, Demographic Performance, and Tax effort, the most concerned criterions were the Income Distance and the Demographic Performance.

Till the 14^th Financial Commission, Population was one of the major criterions. The Commissions took the population as per the 1971 census. But from the 15^th Financial Commission, the population as per the 2011 census is counted and not 1971. This might result in disadvantage for the States which have controlled their population as compared to 1971 Census. Therefore, the Finance Commission introduced a new criterion of Demographic Performance. This new criteria is based on the fertility rate of a State. That is, the distribution is also dependent on the average number of children borne by women of the respective States.

The Income Distance Criterion is largely on the grounds of equity rule. By this criterion, ‘the State having the least per Capita Income will receive the highest share in the tax devolution[2].’

 

Raising Concerns – The two debated criterions; the Demographic Performance and the Income Distance results, in total constitute 57.5% of the Tax Devolution of the year 2020-2021.  This is more than 50% of the tax devolution between the States. Thus, more than half of the share would go to the most populous and poorest States. This puts the States which have their Population in Control and States with high Per Capita Income in a more disadvantaged Position.   

The Southern States of ‘Kerala, Karnataka, and Telangana have Per Capita Income higher than the National Average[3].’ ‘Karnataka will now receive only 3.65% as compared to 4.71% in the previous years. Kerala will only receive 1.94% as compared to 2.5% in the previous years. But the Northern States have seen a significant increase in shares. Bihar’s share had increased from 9.67% to 10.06%. Maharashtra’ share had increased from 5.52% to 6.14% . Rajasthan‘s share had increased from 5.5 % to 5.98%[4].’  The Northern States of Arunachal Pradesh, Bihar, Chhattisgarh, Gujarat, Rajasthan, Madhya Pradesh, Maharashtra, Jharkhand, Nagaland, Mizoram, Punjab, and West Bengal will receive more shares. From the Southern States only Tamil Nadu had seen an increase in the share.

The Southern States of Karnataka, Andhra Pradesh, Kerala, and Telangana opine that the Income Distance criterion and the Demographic Performance Criterion have led fall in their shares. There is also an opinion that, usage of 2011 census data instead 1971 had resulted in fall in shares for the Southern States.

 

Addressing Concerns- There are negative opinions on usage of 2011 population instead of 1971 population for tax devolution. On a logical note, using 50 decade old data (1971) would make the recommendations of the 15^th Finance Commission infructuous and redundant. Therefore usage of 2011 population is the best option in the present economic situation.  To balance the issues arising due this, the Finance Commission had introduced a new indicator of Demographic Performance. “But while calculating demographic performance, the formula takes the inverse of the fertility rate. But then multiplies this with the 1971 population. It is unclear how the size of state is a factor when calculating its performance in “demographic management”[5]. ‘Similarly, the tax effort criterion also includes population. Tax effort, in theory, is supposed to measure, efficiency of tax collection. It is unclear how the size of a state can be a factor in determining how good it is at collecting taxes. As a result, this formula produces inexplicable results.’[6]

 

Conclusion- The Income distance Criterion and the Demographic Performance Criterion had coupled and casted deep effects in the share of the Southern States. The tax effort criterion also has a significant effect on this. There is also criticism on the formulae used to calculate the shares. Thus the best method to resolve this issue would to balance population and state size, before calculating each State’s Share.

 

 

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[1] (Aug.27,2020, 12.59 pm) http://www.egazette.nic.in/WriteReadData/2017/180483.pdf.

[2] Rohin Garg and Saket Surya, Recommendations of the 15^th Finance Commission for 2020-2012, (Aug.26,2020, 12.59 pm), https://www.prsindia.org/theprsblog/recommendations-15th-finance-commission-2020-21.

[3] Asit Ranjan Mishra, Anil Padmanabhan, Finance Commission has sought to balance variables of need, efficiency and equity: N K Singh, (Aug.29,2020, 01.51pm) https://www.livemint.com/politics/policy/finance-commission-has-sought-to-balance-variables-of-need-efficiency-and-equity-n-k-singh-11581223706571.html

[4] Rohin Garg and Saket Surya, Recommendations of the 15^th Finance Commission for 2020-2012, (Aug.26, 2020, 12.59 pm), https://www.prsindia.org/theprsblog/recommendations-15th-finance-commission-2020-21.

[5] Shoaib Daniyal, How 15th Finance Commission is trying to manage South India’s anger over tax division – and failing, (Aug.29, 2020, 01.59 am), https://scroll.in/article/952357/how-15th-finance-commission-is-trying-to-manage-south-indias-anger-over-tax-division-and-failing.

[6] Id.