How States’ Share of Central Taxes Is Determined and How the Formula Has Evolved

Changing Role of Finance Commissions

Allocations from the central divisible tax pool to Indian states are governed by Finance Commissions, which are constitutionally mandated bodies appointed every five years. Over the decades, the formula used by these commissions to determine each state’s share has undergone significant changes, reflecting shifts in policy priorities and economic realities.

From Population and Poverty to Fiscal Capacity and Demographics

In the earlier years, major emphasis was placed on state population figures and poverty levels to decide tax devolution. This approach aimed to address regional disparities through redistribution. However, successive Finance Commissions have progressively reduced the weight of population and poverty in favour of parameters that reward fiscal discipline and incentivise better governance.

One of the key criteria in the present system is *income distance*, which measures the shortfall in a state’s per capita income relative to the richest state. This component is designed to ensure fairness by allocating more resources to states with lower income levels. Although still critical, the weight assigned to income distance has been reduced in recent commissions.

Inclusion of New Criteria Like Demographic Performance

A notable shift has been the introduction of demographic performance as a criterion. This parameter rewards states that have made progress in population control and achieved lower fertility rates. By doing so, the formula seeks to balance the concerns of states that adopted early measures for population stabilisation and might otherwise be disadvantaged if population alone were used as a major factor.

Forest Cover and Environmental Considerations

Another significant addition to the formula is the inclusion of forest cover. States with a large proportion of forested land incur costs related to conservation efforts and face limitations on economic activities in these regions. Recognising this, recent commissions have allotted weight to forest cover to support sustainable development and environmental management.

Contribution to National GDP

In a further evolution, the contribution of a state to national Gross Domestic Product (GDP) has also been introduced as a determining factor. This measure reflects the economic output generated by each state and aims to reward contribution to national income, striking a balance between equity and efficiency.

Balancing Equity and Economic Performance

Overall, the formula has transitioned from a predominantly redistributive model to one that seeks to balance equity with efficiency. It attempts to address both the financial needs of less developed states and the performance of states contributing more significantly to national growth.

The weightage assigned to each parameter varies with every Finance Commission, depending on their assessment of current fiscal and demographic trends. These adjustments ensure that the allocation mechanism remains relevant and responsive to the evolving economic and social landscape across Indian states.