Explained: How south states stand to lose from 15th Finance Commission recommendations

Tamil Nadu is the only southern state that will see its share increase in the new tax-sharing arrangement.

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Less than two years after the south first raised their voice against the “unjust” Terms of Reference (ToR) of the 15th Finance Commission, it appears that all southern states barring Tamil Nadu have emerged the biggest losers in the distribution of tax revenue. Bihar, Madhya Pradesh, Maharashtra, Rajasthan and West Bengal are among the biggest gainers from the new tax-sharing formula.

The Finance Commission is a body that determines how the tax revenues collected by the Union government are distributed among the states. The 15th Finance Commission has been constituted to formulate the distribution of funds among all states for a period of six years.

While the interim report for 2020-2021 was tabled in the Parliament on Saturday, the 15th Finance Commission (15th FC) will submit its final report in October this year for the period 2021-2026. During her Budget speech, Finance Minister Nirmala Sitharaman said, “In the spirit of cooperative federalism, I am pleased to announce that we have, in substantial measure, accepted the recommendations of the Commission.”

So, what are the recommendations of the 15th Finance Commission?

The Commission led by Chairperson NK Singh has recommended a 1% decrease in the net proceeds of tax collected by the Centre to be shared with states. So against the 42% of tax revenue that states were given, as per the 14th Finance Commission (2015-2020), the 15th FC has now recommended that the Centre devolve 41% to states. This 1 percentage point reduction, it says, is to account for the reorganisation of the erstwhile state of Jammu and Kashmir, which has been split into two Union Territories.

As far as how this pool of money is then divided among the states, the 15th FC has made some significant changes to its formulations. In its report, the Commission says that it has taken into account “fiscal needs, equity and performance principles” for determining the criteria and has assigned appropriate weightages.

2011 Census to be used despite opposition

Population is one of the key criteria that has been used to determine how the funds are distributed. However, unlike the previous Commissions, the 15th FC has decided to use the 2011 Census as against the 1971 Census that has been used by the previous nine Commissions for their calculations. This comes despite opposition from several states, especially from the south, that had demanded that the 1971 population data be used. They argued that using the latest Census would penalise them for effective population control measures.

While the 14th Finance Commission had continued to use the 1971 Census, assigning it 17.5% weightage, it also introduced the 2011 Census, giving it 10% weightage. However, unlike its predecessor, the 15th FC has chosen to completely scrap the 1971 Census. It has assigned 15% weightage to the population criterion that is now entirely dependent on the 2011 Census. The Commission has further justified doing so, stating that it had “no further choice” given that the ToR had specifically stated to use the 2011 population data.

New demographic performance criterion to assuage states

However, to offset the concerns of some of the south states, the FC has added a new determinant – demographic performance, assigning it a weight of 12.5%. This uses total fertility rate (TFR) as a measure, rewarding states with lower TFR. Fertility rate is the average number of children a woman has. Arguing that TFR also is an indirect indicator of outcomes like health and education, the Commission hopes to allay some of the fears of states like Kerala that have controlled their population and have achieved better human capital over the years.

Another performance-based criterion is tax effort, which has been re-introduced after ten years. States that collect higher taxes will be rewarded by this parameter. A weight of 2.5% has been assigned to tax effort.

Rewarding forest cover

While the 15th FC has maintained 15% weightage to the area criterion, it has chosen to significantly increase the weight assigned to forest cover. From 7.5%, the Commission has now assigned a weight of 10% for forest cover, choosing to reward states that have “provided ecological services” to the country.

As far as equity-based criteria go, the Commission has decreased the weightage assigned to income distance (distance per capita income of a state) to 45% from 50% in the 14th FC. This criterion essentially attempts to bring poorer states on par with the rest, by allocating more funds to those with lower per capita income.

Setback to the south

Based on these parameters the 15th FC has redistributed the tax share among the 28 states. The new allocations will significantly affect Karnataka, Kerala, Andhra, and Telangana, which will see a reduced share of tax revenue compared to the previous Finance Commission.

Inter se share of states (in %) State 13th FC fund 14th FC 15th FC Andhra Pradesh 6.937 4.305 4.111 Bihar 10.917 9.665 10.061 Karnataka 4.328 4.713 3.647 Kerala 2.341 2.5 1.943 Madhya Pradesh 7.12 7.548 7.886 Maharashtra 5.199 5.521 6.135 Rajasthan 5.853 5.495 5.979 Tamil Nadu 4.969 4.023 4.189 Telangana - 2.437 2.133 Uttar Pradesh 19.677 17.959 17.931 West Bengal 7.264 7.324 7.519

Karnataka has seen the biggest cut, with its tax share slashed by 1.066 percentage points. The state will be given only 3.647% from the divisible pool as against 4.713% in the 14th Finance Commission. Officials estimate that this significant drop means Karnataka could stand to lose between Rs 9,000 and 11,000 crore from the Centre.

Kerala, which was one of the first states to register its protests against the “unfair” Terms of Reference in the 15th FC, will see its share of allocations reduced by 0.557 percentage points. From 2.5% in the previous Commission, Kerala’s share in the divisible pool has dipped to 1.943%. This is expected to cost the state a loss of Rs 4,300 crore. Kerala Finance Minister Thomas Isaac lashed out at the changes, stating, “This is the lowest-ever award to the state by the Finance Commission. Our genuine demands were given a cold shoulder. This budget is a real setback to us.”

Andhra’s share has now reduced to 4.111% from 4.305% in the 14th Finance Commission. The opposition TDP has blamed Chief Minister Jagan Mohan Reddy and his YSRCP government for the reduced allocations. Former state Finance Minister and TDP leader Yanamala Ramakrishnudu stated that Andhra would suffer a loss of Rs 1,521 crore owing to the new tax-sharing formula.

Like its southern neighbours, Telangana will also stand to lose out. As per the 15th FC’s calculations, Telangana’s share has decreased to 2.133% from 2.437% previously, which means the state will lose Rs 3,731 crore from the Centre. Calling it “clear discrimination”, Telangana Chief Minister K Chandrasekhar Rao said the reduction in its share of central tax revenue will impact the development plans of the state.

TN among the biggest gainers

Among the southern states, only Tamil Nadu stands to gain from the 15th Finance Commission’s recommendations. The state’s share in the divisible pool has increased from 4.023% to 4.189%. Welcoming the changes, Deputy Chief Minister and AIADMK leader O Panneerselvam said Tamil Nadu could stand to gain Rs 1,600 crore from the Centre.

Uttar Pradesh continues to get the biggest chunk from the states’ share, taking home 17.931%, a marginal dip compared to the 14th FC. While Bihar’s share increases to 10.061% from 9.665% earlier, Madhya Pradesh and Maharashtra have steadily gained over the last decade. From 7.120% recommended by the 13th FC, Madhya Pradesh’s share has now risen to 7.886%, while Maharashtra has risen from 5.199% between 2010-2015 to 6.135% now. Rajasthan and West Bengal are some of the other states to have gained, with their share in the divisible pool standing at 5.979% and 7.519% respectively.