Fiscal Transfers from the Central Government

March 14, 2013 | By | Add a Comment

Despite India having a federal system, transfer of funds from the center to the states is still limited. Income tax revenue is a major source of income for the union government. Even though it is collected from the states, only 29% of the total income tax revenue is shared by the central government with the state governments. Unless the share is increased to at least around 50%, the fiscal crunch that many states face will continue.

Central Transfers

Growth Rate in Central Transfers                                                                                       Source: Budget-in-Brief documents of various years

The transfer of funds from the Centre to the states is determined by the Central Finance Commission, which is constituted every 5 years. The devolution of funds is done through a formula called “Gadgil Formula”. One of the dependent variables in the Gadgil Formula is the level of social and economic development in the state, which is essentially one of the factors which determine the magnitude of central transfers. Since, on a relative degree, Kerala is socially and economically advanced, the share of central transfers has consistently decreased. Around 3.88% of the share of central transfers was devolved to Kerala under the  Tenth Finance Commission (1995 -2000). It decreased to 2.83% under the Eleventh Finance Commission (2000 – 2005 ). Under the 12th Finance Commission (2005 -2010), it further decreased to 2.7%. The 13th Finance Commission (2010 -2015), it became 2.5%.

Finance COmimissions

                                                                                                                  Source: Budget-in-Brief documents of various years

In the last two decades, fund devolution from the Centre to Kerala has almost halved. There have been plenty of criticisms about the Gadgil Formula. One criticism that has consistently surfaced is that it penalizes states for achieving higher rates of growth by reducing their share of central transfers. Ideally, the Formula should consider incentives for states that are better performers.

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