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divisible tax pool: 15th Finance Commission report: States call for inclusion of cess, surcharge in divisible tax pool


Revenue from cesses and surcharges should be made part of the divisible pool and shared with states while release of local body grants should not be connected with reforms, states and economists have said in response to recommendations of the 15th Finance Commission (FC) report.

“Cesses and surcharges (revenue) must be shared with states but by limiting them to the central pool was further disempowering states,” said Chhattisgarh commercial tax minister TS Singh Deo.

He added that the current tax devolution at 41% to states from the divisible pool was not adequate to meet budgetary provisions since the tax revenue itself had shrunk due to the impact of Covid 19 pandemic on tax collections.

Along with relief that there was no reduction in the devolution from the previous year, a senior official in the Maharashtra state government also expressed concern over the increase in cess.

“When you increase the cesses and decrease the excise on petrol, naturally what is to be distributed to the states will go down. This is a pain point not just for the Maharashtra government but all the states,” he said.

A senior official in the Tamil Nadu government echoed similar concerns. “The Centre has been increasing excise duty on petrol and diesel since May 2020 and in the Budget it has reduced basic custom duty but levied cess… its getting completely out of hand,” he said.

While the increase in Maharashtra’s share to 6.32% in FY21 from 5.52% in the 14th FC report has been retained, a slow recovery could still mean negative growth in absolute terms, the official said.

The Union Budget 2021-22 has put devolution to states from centre’s tax revenue at Rs 6.65 lakh crore as per Budget Estimates versus Rs 7.84 lakh crore in BE of FY 2020-21. This has been reassessed to Rs 5.73 lakh crore for FY 2020-21. Tax devolution was Rs 6.5 lakh crore in FY 2019-20.

The states have a genuine concern in the increase of cesses and surcharges by the Centre, said DK Srivastava, chief policy advisor at EY and former member of the 13th FC.

“If you look at the budget, the shareable pool of tax revenue is 41% but the actual share as budgeted is only 30% of gross tax revenue because of the share of cesses and surcharges and any other portion that is not part of the divisible pool,” Srivastava said.

After 2015-16, there was an enormous increase in cesses and surcharges, which was the central government’s attempt to neutralise the effect of the 14th FC’s recommendation to raise the states’ share to 42% from 32%, according to Srivastava.

Agriculture reforms

The 15th FC recommended grants amounting to Rs 45,000 crore be tied to agriculture sector reforms in land lease, sustainable and efficient water use, export promotion and self-reliance in the production of oilseeds, pulses and wood and wood-based products.

But M Govinda Rao, former member of the 14th FC says the reforms will not be relevant until the Centre accepts the sector-specific grants.

Chhattisgarh’s Singh Deo said that the Centre should assure minimum support price (MSP) in legal terms if reforms are being pushed for doubling farmer income.

“If the Centre is so sure of better returns for farmers, they should not shy away from MSP… the reforms are tilted towards buyer and not seller,” he said.

EY’s Srivastava added that agriculture should not be linked to tax devolution or fiscal transfers because that is subject dealt directly between the central and states.

Local body grants

Another issue that is set to become the bone of contention between Centre and states is conditions being attached to release of funds to urban local bodies, which range from the entry level condition of setting up a state finance commission (SFCs) to various performance-linked incentives.

“This recommendation is ridiculous. There was no need for FC to get into this area. These grants are released to the states outright,” the senior official quoted earlier said.

He added that in some cases if states do not set up the state finance commissions, ULBs would not get any money despite not being at fault.

The 15th FC has proposed Rs 4.46 lakh crore as local body grants of which it has earmarked Rs 1.21 lakh crore for urban local bodies (ULB).

In terms of the volume of fiscal transfers to the states, the 15th Finance Commission (FC) has recommended a total of Rs 52.6 lakh crore over the five year period of FY22-26.

This represented a 41% share of the divisible pool of taxes, along with 1% being retained by the Centre for the Union Territories of Jammu and Kashmir and Ladakh, and the grants-in-aid that are meant to equalise the fiscal capacities of the states and balance their budgets for cost differentials of providing basic public services.

The total transfer has been largely in line with historical trends, with the 14th FC’s recommendations of a 42% share to the states largely being continued. Within the fiscal transfer, tax devolution accounts for 80% while about 20% are in the form of grants.

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