Relevance: GS II (Federalism) & GS III (Economy) | Source: The Hindu

1. Context 

  • The 41% Share: The Union government accepted the 16th Finance Commission’s (FC16) advice to share 41% of its collected taxes with the State governments.

2. Vertical Devolution : The Catch

  • The Hidden Catch: Experts feel this 41% number is misleading. The Centre collects a large amount of money through special extra taxes called Cesses and Surcharges, which does not form part of the divisible pool.
  • Simple Math:  Imagine the Central Government collects a total tax of ₹100 (Gross Tax Revenue). You might think the states will get ₹41, but here is the catch:
  • Step 1 (The Unshared Money): Out of this ₹100, let us say the Centre collected ₹20 as special taxes called Cesses and Surcharges. The Constitution allows the Centre to keep 100% of this money.
  • Step 2 (The Leftover Pool): The remaining money is now ₹80. This leftover amount is called the Divisible Pool.
  • Step 3 (The Actual Math): The Finance Commission’s 41% sharing rule applies only to this leftover ₹80.
  • The Reality Check: 41% of ₹80 is just ₹32.8.
  • So, while the official headline says “States get 41%”, they actually received only ₹32.8 out of the total ₹100 collected. 
  • Because the Centre is steadily increasing these unshared ‘Cesses’, the actual money reaching the states keeps shrinking.

3. The New Rule for Horizontal Distribution

  • Rewarding Growth: When dividing this money among the 28 states (Horizontal Devolution), FC16 introduced a major new rule: “Contribution to GDP” (10%).
  • The Impact: This directly rewards highly industrialized states (like Maharashtra and Tamil Nadu) for making more money. However, it slightly reduces the focus on helping poorer states catch up.

UPSC Value Box

Key Term / Body Simple Meaning
Finance Commission (FC) A Constitutional body created under Article 280. The President forms it every five years to decide how tax money should be shared between the Centre and States.
Cess and Surcharge Extra taxes collected by the Centre for a specific purpose (like education or health). This money is strictly kept out of the shared tax pool.
Horizontal Devolution The formula used to divide the total state share among individual states based on their population, area, and economic needs.

With reference to fiscal federalism and the Finance Commission in India, consider the following statements:

  1. Revenue collected by the Union government through cesses and surcharges is a mandatory part of the divisible pool shared with the States.
  2. The Finance Commission is a statutory body constituted under the Ministry of Finance.
  3. The 16th Finance Commission introduced “Contribution to GDP” as a new weightage criterion for horizontal tax devolution among states.

Which of the statements given above is/are correct?

(a) 1 and 2 only

(b) 3 only

(c) 2 and 3 only

(d) 1, 2 and 3

Correct Answer: (b)

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