North-South Debate: Money And Equity In A Fine Balance

Delhi’s Jantar Mantar has already hosted two colourful rallies on two consecutive dates this week, where chief ministers and leaders of political parties from southern India have joined hands to highlight demands for the dispersal of more funds from the central kitty for their respective states. The demonstrations also sparked off social media debates with claims and counterclaims on the issue, raising the political temperature in the capital.

The crux of the battle lies over whether the centre is doling out a just share of funds to the states and whether the spoils given out are equitably spread out across states.

The issue has been a sensitive one over the decades and has always been a dilemma, which successive federal governments have tried to address as they balanced the desire to bridge the developmental divide between various parts of India and the need to reward states that performed better than others.

In the coming financial year 2024-25, the central government will be transferring Rs 22.74 lakh crore to states and union territories. This will be an increase of 8.4 per cent over the revised estimates of 2023-24. The transfer to states includes devolution of Rs 12.19 lakh crore out of the divisible pool of central taxes.

While the figures sound impressive, the problem arises firstly as the devolution of resources from the centre to states is lower compared to recommendations by finance commissions. Secondly, there has been a trend towards a gradual reduction in the total divisible pool of taxes collected by the federal government which has been raising more and more money by way of cesses, which it does not have to share with state governments.

A study by India Rating and Research into the budget outlays for 2024-25, shows that the federal government will be dispersing about 35.5 per cent of the divisible pool of taxes. This pool is basically the gross tax revenues of the central government, less cesses and surcharges and taxes of union territories.

This is against the Fifteenth Finance Commission’s recommendation that 41 per cent of the gross net revenues of the federal government be given to the states as their share.

The RBI in its latest “Study of State Finances”, underlined that a lower share than recommended by the finance commission in the divisible pool constrains the states’ fiscal capacity to carry out developmental works.

The RBI report pointed out that, “major surcharges levied by the Union government include surcharge on personal income tax for those with taxable income more than Rs 50 lakh and surcharge on corporate income tax for those companies whose net income exceeds Rs 1 crore. Due to an increase in cesses and surcharges, the divisible pool has shrunk from 88.6 per cent of gross tax revenue in 2011-12 to 78.9 per cent in 2021-22, despite the 10 percentage point increase in tax devolution recommended by the finance commission.”

All the cesses and surcharges (excluding GST compensation cess) collected by the revenue department of the federal government have been budgeted at 10.2 per cent of the gross tax revenue for the financial year 2024-25.

The flip side of the coin which is attracting equal controversy is how is the money being given to states, divided up. A rough back of the cover calculation shows that the five south Indian states together account for 15.79 per cent of the net proceeds of the Union taxes and duties for 2024-25, which are being divvied up between states. On the other hand, the five north Indian states – Bihar, Chhattisgarh, Jharkhand, Madhya Pradesh and Uttar Pradesh – account for a whopping 32.55 per cent of the funds being disbursed.

Tamil Nadu which accounts for the second largest shares of taxes that are collected from states, after Maharashtra, will get just 4.08 per cent in 2024-25, while Uttar Pradesh gets about 17.94 per cent, more than all five southern states combined and Bihar, another 10.05 per cent.

Behind all this of course is the logic that prompts finance commissions’ recommendations on the division of taxes and the fact that population is a major factor in this thought process.

The rule which was made in 1976, through the 84th amendment to the Constitution, was that till 2001, the census figures of 1971would be taken into account to decide on the population weightage given while distributing central taxes. This was done to incentivise population control in states.

This carrot and stick policy or perhaps better social indicators such as literacy and health saw the southern states vigorously adopt family planning, bringing down their population growth considerably.

For instance, the population growth of the five southern states has been between 57 per cent to 90 per cent in the period 1971 to 2011, whereas it has been between 130 per cent to over 150 per cent for the five north Indian states – Bihar, Jharkhand, M.P, Chhattisgarh and U.P – during the same 40-year period. Kerala of course had the lowest population growth among all these states while Bihar reported the highest.

Since 2000, the rule adopted favoured taking into account the latest census along with the 1971 one to work out the population weightage. For instance, the Fourteenth Finance Commission gave a weightage of 17.5 per cent to the 1971 population figures and 10 per cent to the 2011 population figures.

However, this changed, with the Fifteenth Finance Commission, which took the population figures for the 2011 census alone into account, causing many southern states to voice objections at that time.

This is really where the North-South divide debate assumed a more serious character as against a mere joke or academic banter. North Indian heartland states such as Uttar Pradesh, Madhya Pradesh and Bihar have been reporting high growth of population, decade after decade, and they seemed to be garnering a progressively larger share of resources compared to states that had done well by strictly adopting family planning.

The Sixteenth Finance Commission, which will begin its sittings later this year, has been given terms of reference where it will have the freedom to decide on which census to take into account while deciding on the population as a weightage for deciding on the division of resources between states.

While it is not known which census year the committee will choose, the fact is that analysts who support the notion that the South is losing out, have started coming up with notional figures on how much money has been lost to their states by changing the formula for allocation of resources by the N.K.Singh-led Fifteenth Finance Commission.

However, the fact also remains that each finance commission has to look into the equity of its decision on dividing up money between states and this includes the need to address the developmental deficit of large swathes of India, which have not benefited from the economic prosperity that has flooded the country since it experienced a perestroika-like liberalisation in 1991.

As a result of the rapid industrialisation and improvement in their social development indicators, the five southern states now boast of a uniformly high per capita income of between Rs 2.28 lakh a year to Rs 3.08 lakh a year (as of 2022-23). Whereas the five north Indian states have a per capita income of between just Rs 50,000-Rs 1.4 lakh per year.

There is obviously a need to bring some kind of a balance between the two sets of states or else the federal structure will be where the the country will have two sets of states - one rich and one poor. At the same time performance of state governments too will need to be encouraged. How the balancing act will be done is really what is at stake in today's context as the federal authorities will need to satisfy both sides of the divide and yet bring equity and justice in its dealings with constituent states.