The 16th Finance Commission, whose recommendations take effect from FY 2026–27, is under increasing pressure to reassess the formula used to divide the divisible pool of tax collections between the Centre and the States.
About the Divisible Pool of Tax Collections
- The Divisible pool is that portion of gross tax revenue which is distributed between the Centre and the States.
- The divisible pool consists of all taxes, except surcharges and cess levied for a specific purpose, net of collection charges.
Key Points
- Present Share: States currently receive 41% of the divisible pool.
- Demand: 22 out of 28 States (including BJP-ruled ones) want it increased to 50%.
- Rationale Behind Demand: Cesses and surcharges have risen from 12.8% to 18.5% of the Centre’s gross tax revenue in recent years.
- Major Contention: The effective share of States in the Centre’s gross tax revenue has dropped from 35% (2015–2020) to around 31% (2020–2024) due to increasing use of cesses and surcharges, which are not part of the divisible pool.
- Horizontal Devolution Concerns: Current criteria, which heavily weigh population and income distance, are seen by developed States (especially in the South) as penalising efficiency and performance.
Allocation Mechanism
Vertical Devolution
- Vertical devolution refers to the distribution of central tax revenues between the Union (central) government and the states.
- It determines what percentage of the total central taxes is allocated to all states collectively.
- For the 2021–26 period, this share is 41%, as recommended by the 15thFC.
Horizontal Devolution
- Horizontal devolution refers to the distribution of the states’ collective share (as decided in vertical devolution) among individual states.
- It decides how the 41% (15th FC) is divided among the states.
|
| Article 271 – Parliament can levy surcharges on certain taxes for Union needs; these are not shared with States.
Cess:
- A specific levy imposed for a targeted purpose (e.g., education, health).
- Added to the Consolidated Fund of India, but can be spent only on the specified purpose.
- Not part of the divisible pool – Centre is not obligated to share with States.
Surcharge:
- An additional charge on existing taxes, often applied to high-income individuals or entities.
- Designed to increase revenue without changing the general tax rates.
- Also forms part of the Consolidated Fund, but not shareable with States.
|
Key constitutional articles on Centre–State fiscal relations
- Article 268 – Union levies certain duties (e.g., stamp duties, excise on medicinal items), but States collect and retain the proceeds.
- Article 269 – Union levies and collects inter-State trade taxes, but assigns proceeds to States as per Parliament’s distribution principles.
- Article 270 – Union taxes (excluding those in Articles 268, 269, and surcharges) are shared with States based on Finance Commission recommendations.
- Article 280 – Mandates a Finance Commission every five years to recommend Centre–State financial distribution.
|
Finance Commission of India
- Established under Article 280, it is a quasi-judicial body.
- Constituted by the President of India every five years or as needed.
- Composition: Includes a Chairman and four other members, all appointed by the President.
- Tenure: As specified by the President; members are eligible for reappointment.
- Qualifications:
- Chairman: Must have experience in public affairs.
- Other members: Must include at least one with each of the following:
- A High Court judge or one qualified to be;
- An expert in finance and accounts of government;
- A person experienced in financial matters and administration;
- A person with specialised knowledge of economics.
- Removal: Can be removed by the President, with grounds including:
- Unsound mind;
- Involvement in a vile act;
- Conflict of interest.
16th Finance Commission (SFC)
- Established to recommend tax devolution formula for the five-year period beginning 1 April 2026.
- Chairman: Arvind Panagariya, noted economist and former Vice Chairman of NITI Aayog.
- Deadline for submission of recommendations: 31 October 2025.
|
To get PDF version, Please click on "Print PDF" button.
PWOnlyIAS
