Centre Tax Devolution Funds Released To States
| General Studies Paper II: Co-operative Federalism, Government Policies |
Why in News?
Recently, the Union Government front-loaded an advance tax devolution instalment of ₹1.09 lakh crore to all states to accelerate critical capital and developmental expenditure.
- Uttar Pradesh received the highest ₹19,208 crore, Sikkim the lowest ₹365 crore allocation.
What is Tax Devolution?
- About: Tax Devolution is the constitutional transfer of a fixed share of Central taxes to State Governments.
- It gives states predictable funds for governance, development and welfare without repayment obligations.
- It is the backbone of India’s fiscal federalism.
- Constitutional Basis: The system is mainly governed by Article 270, which provides for sharing Union taxes with states.
- Article 280 establishes the Finance Commission to recommend such a sharing formula.
- The Finance Commission (currently 16th Finance Commission) is appointed every five years by the President.
- It recommends vertical devolution (Centre–States share) and horizontal devolution (distribution among states using objective socio-economic criteria).
- Distribution Process: The Centre collects taxes, forms the divisible pool, and transfers the prescribed share to States after the President accepts Finance Commission recommendations.
- The Divisible Pool includes the net proceeds of Union taxes after deducting collection costs. It excludes cesses and surcharges, making them non-shareable with states.
- The divisible pool mainly covers Income Tax, Corporation Tax, Central GST, and the Centre’s share of eligible Union taxes. Cess and Surcharge under Article 271 are not shared with States.
- These revenues form the largest source of unconditional transfers to states.
- Devolution Share: The 16th Finance Commission retained the states’ share at 41% of the divisible pool for 2026–31.
- It is the continuation of the recommendation of the 15th Finance Commission.
- Criteria for Distribution: Important criteria include Income Distance, Population, Area, Forest and Ecology, Demographic Performance, and Contribution to GSDP under the latest framework.
- The latest formula percentage covers: Income Distance (42.5%), Population 2011 (17.5%), Area (10%), Forest & Ecology (10%), Demographic Performance (10%), and Contribution to GSDP (10%).
- Usages: States can use tax devolution for capital expenditure, infrastructure, social welfare, salaries, healthcare, education, rural development, disaster management and other essential public services according to their budget priorities.
- Significance: Tax devolution reduces the vertical fiscal imbalance because the Centre raises more taxes while States spend more on health, education and welfare.
- Tax devolution ensures stable funding for these constitutional responsibilities and infrastructure projects.
- Special Point: Tax Devolution is a constitutional share of Central taxes distributed through a formula.
- Grants-in-Aid under Article 275 are additional targeted transfers for specific needs or revenue gaps.
- It is allocated selectively to states that require extra support after tax devolution.
| Note: The current 16th Finance Commission is chaired by former NITI Aayog Vice-Chairman Dr. Arvind Panagariya. Constituted for the five-year period spanning from April 1, 2026, to March 31, 2031. Its full-time members include Ajay Narayan Jha, Annie George Mathew, and Dr. Niranjan Rajadhyaksha, alongside part-time members Dr. Soumya Kanti Ghosh and T. Rabi Sankar. |
Recommendations of 16th Finance Commission
- Vertical Tax Devolution: The Commission retained States’ share at 41% of the divisible tax pool, continuing the 15th Finance Commission formula.
- It introduced “Contribution to GDP” as a new distribution criterion. This replaces the earlier Tax and Fiscal Effort indicator.
- The 16th Finance Commission abolished Revenue Deficit Grants, Sector-Specific Grants and State-Specific Grants.
- Fiscal Discipline: The Commission recommended stronger fiscal responsibility, asking the Union to reduce its fiscal deficit to 3.5% of GDP by 2030–31 while States should maintain a 3% of GSDP fiscal deficit limit.
- The Commission recommended that off-budget borrowings should be discontinued and fully reflected in government budgets.
- Total Grants Recommended: The 16th Finance Commission recommended ₹9.47 lakh crore in grants-in-aid for 2026–31, separate from tax devolution.
- These grants mainly support local governments and disaster management, strengthening grassroots governance.
- Allocation to Local Governments: The Commission allocated ₹7,91,493 crore to Panchayats and Urban Local Bodies (ULBs).
- This reflects greater emphasis on decentralised governance, and constitutional empowerment of local institutions.
- Support for Rural Local Bodies: Rural Local Bodies received ₹4,35,236 crore. Of this, ₹3,48,188 crore is Basic Grant, while ₹87,048 crore is Performance Grant.
- Urban Local Body Grants: The Commission recommended ₹3,56,257 crore for Urban Local Bodies.
- It includes ₹2,32,125 crore as Basic Grants, ₹58,032 crore as Performance Grants and additional infrastructure-focused assistance for rapidly growing cities.
- Special Infrastructure Grants: A new Special Infrastructure Component of ₹56,100 crore targets cities with 10–40 lakh population.
- The money is specifically linked to comprehensive wastewater management systems, improving urban sanitation.
- Urbanisation Premium Grant: The Commission introduced a new Urbanisation Premium of ₹10,000 crore.
- It supports peri-urban village mergers with municipalities and preparation of Rural-to-Urban Transition Policies, addressing India’s fast urban expansion.
- Disaster Management Funding: The Commission proposed a ₹2,04,401 crore disaster management corpus for SDRF and SDMF.
- The Centre’s contribution will be ₹1,55,916 crore, strengthening preparedness for climate-related and natural disasters.
- For disaster funds, the Centre recommended 90:10 funding for North-Eastern and Himalayan States, while 75:25 will continue for other States.
- Tied and Untied Grants: Within Basic Grants, 50% remains untied, allowing local priorities.
- The remaining 50% is tied to drinking water, sanitation and solid waste management.
Importance of Fiscal Federalism in India
- Strengthens Cooperative Federalism: Tax devolution gives States an assured constitutional share of Union taxes.
- This reduces dependence on discretionary transfers and strengthens cooperative federalism, where both Union and States jointly pursue national development goals.
- Promotes Fiscal Autonomy: Regular tax transfers increase the financial independence of States.
- They can design welfare schemes, infrastructure projects and sectoral priorities according to local needs without waiting for case-by-case Central approvals.
- Reduces Regional Imbalances: The Finance Commission’s formula directs relatively larger resources to economically weaker States.
- This helps narrow regional disparities in income, infrastructure and public services, supporting balanced national development.
- Supports Quality Public Services: States undertake nearly 60% of public expenditure in sectors such as health, education, agriculture, rural development and policing.
- Predictable transfers help maintain uninterrupted delivery of these essential services.
- Improves Capital Investment: Stable revenues encourage States to invest in roads, irrigation, power, transport, digital infrastructure and urban facilities.
- Such capital expenditure creates long-term assets and raises economic productivity.
- Boosts Inclusive Economic Growth: Additional resources support MSMEs, agriculture, skill development, social protection and employment programmes.
- These investments expand livelihoods while promoting sustainable economic growth across regions.
- Builds Trust Between Governments: A transparent constitutional transfer mechanism reduces Centre–State financial disputes.
- Predictable resource sharing improves policy coordination, consultation and trust within India’s federal governance structure.
Frequently Asked Questions (FAQs):
1. What is tax devolution in India?
Tax devolution is the constitutional sharing of the Union’s divisible tax pool with States through the Finance Commission.
2. Why has the Centre released ₹1.09 lakh crore to states?
To strengthen state finances, support development spending and ensure timely availability of funds for public services.
3. How is tax devolution calculated?
It is calculated using Finance Commission criteria like income distance, population, area, forest, demographics and GDP contribution.
4. Which Finance Commission determines tax devolution?
The Finance Commission, a constitutional body under Article 280, recommends tax devolution every five years.
5. How does tax devolution benefit states?
It improves fiscal autonomy, infrastructure, welfare spending, public services and balanced regional development across States.
6. Is tax devolution different from grants-in-aid?
Yes. Tax devolution is formula-based tax sharing; grants-in-aid are purpose-specific financial assistance from the Centre.
Disclaimer: Information in this article is based on official announcements and public records. Regulations and implementation details may evolve over time.
