Date: 09/09/2022

Relevance: GS-2: Functions and responsibilities of the Union and the States, issues and challenges pertaining to the federal structure, devolution of powers.

Key Phrases: State Finances, tax devolution, Financial Relations, Constitution, tax-revenue, Article 268, Article 269, Art.275, Art.282, Devolution, Centrally Sponsored Schemes, Finance Commission, Union Budget, Interest-free cap-ex loan scheme, borrowing ceiling, off-budget borrowings.

Why in News?

• Recently, the Centre released two instalments of tax devolution totalling Rs 1.16 lakh crore to states. This is in line with the commitment of the government to strengthen the hands of states to accelerate their capital and developmental expenditure.

Centre-State Financial Relations as per in Indian Constitution:

• Articles 268 to 293 deal with the provisions of financial relations between Centre and States.
• It has provisions relating to:
  • Distribution of the tax-revenue
    • Article 268: Taxes levied by the Union but collected and kept by the States.
    • Article 269: Taxes levied and collected by the Union but assigned to the States.
    • Article 270: Taxes levied and collected by the Union, and distributed between the Union and the States.
  • Grant-in-aid from the Centre to the States.
    • Art.275: Statutory Grants: These grants are given by the Parliament out of the Consolidated Fund of India to such States, which are in need of assistance.
    • Art.282: Discretionary Grants: It enables the Union to make discretionary grants to states, even beyond their respective legislative competencies, for any ‘public purpose’.
  • Sharing of proceeds from other taxes.
    • In giving recommendations with regard to the distribution of funds between the centre and state, the Finance commission mentioned under Article 280 plays a very important role.

Various instruments of financial sharing between union and state:

• Devolution (States’ share of taxes):
  • As per the 15th Finance Commission Recommendations, 41% of the divisible pool should be devolved to the States. (Vertical devolution)
  • While distributing the 41 per cent among states, the formula recommended by the Finance Commission should be used – which takes into weight different parameters like Income Distance, Population of 2011, Area, Forest & Ecology, Demographic Performance and Tax Effort.
• Scheme Related Transfer:
  • Another major transfer from the Center to states is in the form of Centrally Sponsored Schemes (CSS). This is part of the Union Budget.
  • Centrally Sponsored Schemes are divided into Core of the Core Schemes and Core Schemes.
• Finance Commission Grants:
  • Based on Finance Commission recommendations, the Center also gives states:
    • Revenue Deficit Grants
    • Sectorial Grants
    • Performance-based Incentives.
  • It mentioned in the Union Budget.

Union government initiatives to boost State government finance capacity:

• Three recent developments have brightened the outlook for capital expenditure by state governments.
  • Union government has stepped up tax devolution
    • The Centre has stepped up the amount of tax devolution to states, releasing a double tranche in August.
    • Centre estimates that Rs 3.2 lakh crore has been devolved in the first five months of this year.
    • This implies a growth of 49 per cent over the corresponding period last year.
    • This should encourage the states to step up their capital spending in the post-GST compensation months.
  • Interest-free Capital expenditure loan scheme for states
    • The Centre massively stepped up interest-free loans to states, which are earmarked for capital spending.
    • The scheme for special assistance to states for capital investment was launched in October 2020 as part of the measures to support economic activity, which had been negatively impacted by the Covid-19 pandemic.
    • In the Union budget 2022-23, the Centre had stepped up the allocation towards this scheme to Rs 1 lakh crore for the current fiscal from under Rs 15,000 crore in the previous two years.
    • This amount will be given to the states as a loan, over and above the normal borrowing ceiling fixed.
    • The guidelines for the usage of the funds under the Capex scheme permit the states to settle their pending bills for ongoing capital projects in addition to using them for new and ongoing capital projects that are duly approved by the Centre.
  • Adjustment of off-budget borrowings
    • The latest guidelines by the Centre indicate that states’ off-budget debt only for 2021-22 would be adjusted over a four-year period beginning 2022-23 and ending in 2025-26.
    • This could provide relief to those states that had undertaken large off-budget borrowings in the previous two years, thereby creating the fiscal space for states to ramp up capital spending.

Way forward:

• Given the rising interest rates scenario, it makes economic sense for the states to avail the interest-free borrowing for fresh capital spending and/or clearing pending bills.
• Based on current projection, tax devolution will need to be as high as Rs 9.3 lakh crore this year, overshooting the budget estimates. So, there is a need to more tax devolution in coming time.
• This tax devolution would enable states to plan their capital spending, given the lead time required to plan and execute capital projects. It may also result in more accurate assessments of their quarterly market borrowings.

Sources: Indian Express

Mains Question:

Q. “Higher devolution, interest-free loans and easing of restrictions will ease stress on state finances”. Discuss [250 Words].