Centre To Slash States' Tax Share Starting FY27, Says Report

The centre's fiscal deficit for 2024-25 is projected at 4.8 per cent of GDP, while states are expected to have a fiscal deficit of 3.2 per cent of the national GDP

The proposal is expected to be approved by the cabinet of ministers, chaired by PM Modi, by the end of March

Source : ABPLIVE AI

The central government is looking to reduce the tax revenues allocated to states. The proposal will be presented to the Finance Commission of India, which is constitutionally appointed to make recommendations on tax sharing and other aspects of Centre-state fiscal relations. This move could potentially escalate tensions between the two levels of government, according to a Reuters report citing three sources with direct knowledge of the matter.

The panel, led by economist Arvind Panagariya, is expected to submit its recommendations by October 31, with implementation planned for the fiscal year 2026-27. These recommendations will be binding.

One of the sources stated in the report that the centre will suggest reducing the share of taxes allocated to states to at least 40 per cent, down from the current 41 per cent.

The proposal is expected to be approved by the cabinet of ministers, chaired by PM Modi, by the end of March, after which it will be sent to the Finance Commission, according to a second source, as per the report.

Possible Collections

A 1 per cent reduction in the states' share of tax revenues could generate around Rs 35,000 crore for the centre, based on projected tax collections for the current year. The final amount will vary depending on the tax collections of each individual year.

The share of taxes allocated to state governments has increased from 20 per cent in 1980 to 41 per cent today. However, the centre's spending needs, particularly during economic slowdowns, have risen. This has prompted calls to reduce the share of tax revenues going to states, according to the first source, the report added.

Fiscal Deficit

The centre's fiscal deficit for 2024-25 is projected at 4.8 per cent of GDP, while states are expected to have a fiscal deficit of 3.2 per cent of the national GDP.

States account for over 60 per cent of total government spending, with a focus on social infrastructure like health and education, while the centre prioritises physical infrastructure.

However, states have limited revenue-raising abilities following the implementation of the national Goods and Services Tax (GST) in July 2017.

Since the COVID-19 pandemic, the centre has increased the share of cesses and surcharges, which are not shared with the states, to over 15 per cent of gross tax revenue, up from 9 per cent-12 per cent earlier.

A shift in the resources available to states could affect their spending priorities. The centre is also likely to propose measures to discourage states from offering cash handouts, debt waivers, and other "freebies" for political gain, the report said.

One possible approach would be to link federal grants provided to states, intended to cover tax revenue shortfalls, to the fulfilment of certain conditions. States would only be eligible for these grants after meeting the conditions. It remains unclear whether the federal government would deny grants to states offering freebies.