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.
