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Financial Devolution in India 

Financial Devolution in India : Overview

  • Refers to the transfer of financial resources and fiscal decision-making from the Union to the States.
  • Seeks to strengthen cooperative federalism by enabling States to plan and execute development responsibilities effectively.

Constitutional Basis

  • Article 270 provides for the distribution of the net proceeds of taxes between the Centre and the States.
  • The Finance Commission is constituted every five years to recommend:
    • Vertical devolution (Union–State share in the divisible pool)
     • Horizontal devolution (distribution among States)
     • Grants-in-aid to States
  • Cess and surcharge collected by the Union are excluded from the divisible pool.
  • The 16th Finance Commission will recommend devolution for 2026–31.

Current Structure of Tax Devolution

  • Vertical devolution is fixed at 41 percent of the divisible pool as recommended by the 15th Finance Commission.
  • Horizontal devolution considers measurable indicators to ensure equity among states.
  • Grants-in-aid supplement devolution to support revenue-deficit States and sector-specific needs.

Criteria Used for Horizontal Devolution

  • Income Distance: Gives higher weight to States with lower per capita income.
  • Population (2011): Used as the demographic base for distribution.
  • Forest and Ecology: Rewards States with a higher share of dense forest cover.
  • Demographic Performance: Incentivizes States with better population control outcomes.
  • Tax Effort: Recognizes greater efficiency in own tax collection.

Major Issues in Financial Devolution

  • Rising share of cess and surcharges reduces the divisible pool, lowering the actual share of States.
  • Concerns over inadequate compensation mechanisms post-GST implementation.
  • States demand greater flexibility in the use of central transfers.
  • Perception of mismatch between States’ contribution to central taxes and the resources devolved to them.

Way Forward

  • Review of the fiscal federal framework to address gaps in the devolution mechanism.
  • Strengthen performance-linked incentives for governance quality, transparency, and service delivery.
  • Enhance the role and capacity of oversight institutions such as the Comptroller and Auditor General.
  • Improve predictability, transparency, and stability of federal financial transfers.

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