Money matters: 3 things at the heart of the North-South debate

The capital city of Delhi has been roiled by two days of protests, led by two of South India’s Chief Ministers – Kerala’s Pinarayi Vijayan and Karnataka’s Siddaramaiah – to draw attention to what they termed as fiscal “injustice” to the states in the devolution of revenues from the central pool.

This has once again placed the focus on a not-so-new controversy of how the cookie crumbles as far as the devolution of federal financial resources to states goes.

The issue has been brewing for some time ever since the terms of reference for the 16th Finance Commission were laid out last November, where the commission was given the freedom to choose the census year which would serve as the base for fixing how much money would be given to which state.

Heart of the debate

Most of the finance commissions in the last 50 years had either used the 1971 population figures or a combination of the 1971 census and the 2011 census, with greater weightage to the 1971 figures in deciding on devolution of money from the central pool.

At the heart of the North-South financial-divide debate lie three things – the rising population growth of the North as against the slowing population growth of the South coupled with its prosperity; lower devolution of resources to states compared to recommendations by finance commissions; and gradual reduction in the total divisible pool because of the Centre collecting cesses which do not have to be shared with the states, instead of taxes which need to be shared.

Population growth

Since 1971, when family planning was adopted, the southern states have done extremely well in keeping a lid on their population growth. Between 1971 and 2011, they saw population growth of between 57 per cent and 108 per cent.

The Hindi heartland, in contrast, saw a growth of 130-150 per cent in the same period.

Since population is an important criterion for dividing up resources between states, this growth means that the finance commission, if it chooses to go by the population of the state, will be giving away far more money to North Indian states than was given before.

Share of taxes

Many different estimates are being shared in the public domain of how southern states get a fraction of the money they raise as taxes for the centre, while poorer states in northern India get far more than the money they raise as resources for the country.

However, one has to remember that in a federation, the Constitution-makers and various planners took a conscious decision to try and spread benefits that had accrued to certain states because of their natural geo-economic positioning among poorer states to bridge the regional divide.

At one time, a steel-and-coal freight equalisation policy was devised which helped southern and western states to industrialise faster at the expense of eastern India where the coal, iron, and steel industries had been rooted.

Central pool

Now let’s come to the amount of central revenues that have to be given to states and what has actually accrued to them. This has sparked off the immediate round of recriminatory statements by a number of state leaders.

According to a study by India Rating and Research, for the financial year 2024-25, the Centre has earmarked about 35.5 per cent of the divisible pool of taxes – which is gross tax revenues net of cesses and surcharges and taxes of union territories. In contrast, the divisible pool was at nearly 40 per cent in the financial years 2016-2020.

This too was lower than what was recommended by the 14th and 15th Finance Commissions which had sought devolution of 42 per cent and 41 per cent of gross net revenues.

Central cesses – bone of contention

One important bone of contention has been the case of cesses which are used exclusively by the Centre, much to the chagrin of many state governments.

An RBI study on state finances released in December last year clearly shows that the divisible pool of taxes has shrunk from “88.6 per cent of gross tax revenue in 2011-12 to 78.9 per cent in 2021-22”.

This effectively means that within these 10 years, the divisible pool has shrunk by nearly 9.7 per cent even as the gross amount distributed to states has kept going up!

The total cesses and surcharges (excluding GST compensation cess) collected by the Union government has been budgeted at 10.2 per cent of the gross tax revenue in financial year 2024-25. Which means about ₹1.21 lakh crore of money will be raised through cesses alone in 2024-25. And obviously none of this will be shared with the states.