[ Fiscal relations between the Union and the States have remained an important cornerstone for growth and sustainability of federalism in India. The foundation for fiscal federalism is indeed the Constitution of India. The imprints of federalism prevailing in the country under the British Rule immediately prior to Independence too had a bearing in the matter. However, steering the Constitutional intent in its true spirit has remained the main task assigned to the Finance Commissions. Even though the relevant provisions of the Constitution remained largely intact for a long period, till the year 2000, yet the Finance Commissions consistently strived to lend a dynamism to the implementation of those provisions. ]
Devolution of taxes and duties constitutes one of the most significant dimensions of federalism in India. These arrangements bear in a good measure impressions of the scheme of Federal-State financial relations that preceded the Independence.. While transition from British Rule to Independence meant considerable upheaval for the people in the social and political sense, quite surprisingly, the effect of this transition on federal fiscal arrangements did not show any such turmoil. The broad principles of public financial policies, including those relating to devolution and distribution of taxes, pursued by the British administration were adopted by the makers of free India's Constitution, albeit with some variations. It would be interesting to trace the developments in this field over several decades of the British rule. However, the focus of this paper being post-Independence India, the background would be drawn from the period immediately preceding the Independence.
Functional distribution under the Constitution
Article 1 of the Constitution of India proclaims that India shall be a Union of States. India today comprises twenty-eight States and seven Union territories. The Constitution has provided for distribution of functional responsibilities as well as of taxation and other regulatory authority between the Union (the Centre) and the States. A full schedule (VIIth) has been provided in the Constitution that enlists these provisions. This schedule has three lists: List-I, called the Union List, enumerates the powers and functions assigned exclusively to the Centre, List-II (the State list) enumerates the powers and functions assigned exclusively to the States, whereas List-III, called the Concurrent List, enumerates the powers and functions assigned concurrently to the Centre as well as the States. The residuary powers and functions have been assigned to the Centre, vide article 248 and Entry 97 of List-I. The Constitution has made a specific declaration that in case of any inconsistency between a law made by the Union Legislature (Parliament) and any law made by the Legislature of a State, the Union law shall prevail to the extent of the repugnancy (article 251). It is generally concluded that the arrangements for Union-State relationship provided in the Constitution is indeed federal but with an upper hand to the Centre.
The functions of governance enumerated in the Seventh Schedule can be classified as developmental, commercial, regulatory, and taxation. In that classification, it is seen that the developmental functions exclusively assigned to the States are agriculture and its allied activitie and no significant developmental functions have been exclusively assigned to the Centre. The Concurrent List has a few significant developmental item, namely, education, economic and social planning, social security, employment and unemployment. On the other hand, most of the commercial functions have been assigned to the Centre, to the exclusion of the States. Of the regulatory functions, the most significant ones are external security (defence) which is assigned to the Centre, and internal law & order, which has been assigned to the States. Many of the commercial functions enumerated in the Seventh Schedule have regulatory components as well. In respect of taxation powers, all major taxes, such as the income tax, corporation tax, excise duties (except on liquors) and custom duties, are assigned to the exclusive domain of the Centre. States are give exclusive domain in respect of intra-State sale of goods (and not services), property taxes and a slew of minor taxes. The residuary power of taxation vests in the Centre and a very significant item under this category is the service tax which has been introduced a few years ago and has started giving very good yield of revenue.
A comparison of expenditure responsibilities of the Centre with that of the States would give the unmistakable impression that items of significant revenue expenditure are far more with the States than with the Centre. In fact the most significant revenue expenditure item for the Centre would be defence including maintenance of the armed forces. All other regulatory and commercial functions assigned to the Centre are either net revenue contributors or require low revenue expenditure. The only exception that can be expected to require significant revenue expenditure from the Centre is education, which is in the Concurrent List. On the other hand, a review of the revenue authority of the Centre vis-à-vis that of the States would give the clear inference that the most potent revenue items are retained for the exclusive domain of the Centre. All primary taxes on incomes- of individuals as well of corporates, on goods in the form of excise duties and customs and even the service tax, that have high buoyancy and yield potential, are vested in the exclusive domain of the Centre, leaving secondary taxation on these sources for the States. The exceptions are, however, property taxes and excise duties on liquors, which are given to the exclusive domain of the States, but the yield of these taxes is not too high.
The framers of the Constitution had made such distribution of authority and responsibilities with a clear vision and purpose. During the period the Constitution was being drafted, the economic conditions prevailing in the country were highly uneven and, in the overall, very weak. The country needed a strong Central governance in many respects, particularly for the fiscal policies and administration. Thus, there was ample justification for keeping the major items of taxation in the Union List. On the other hand, in respect of expenditure responsibilities, the basic needs of the people, in terms of food, agriculture, local road communication, health care, basic education, etc. were in abysmal stages and required highly focused and localised efforts for planning and implementation. Accordingly, these items, though of high revenue requirements, were placed in the State list. In fact, education was brought into Concurrent List only at a later point of time through the Forty-second Amendment, in 1976.
The distribution of revenue expenditure responsibilities and taxation authority between the Centre and the States was obviously expected to lead to a situation of surplus on revenue account for the Centre and of deficit, for the States. Accordingly, the Constitution makers made arrangements for distribution of a part of the revenue resources of the Centre with the States. In this arrangement, they were indeed influenced by the arrangements existing prior to Independence, in the British administered provinces that were governed by the provisions of the Government of India Act, 1935 (or, the GOI Act, 1935). Having studied the arrangements of fiscal transfers obtaining under that Act, as also in other federations, the Constitution makers provided for a scheme of transfers that included both tax sharing and grants-in-aid. Such fiscal transfer has the vertical component which determines the total sum that would be transferred from the Centre to the States and the horizontal component which determines the inter se share of States.
Tax sharing arrangement under the GOI Act, 1935
Under the Government of India Act, 1935 (GOI Act 1935) which lasted for the eight year period from 1935 to 1947, the only Federal tax that was to be shared with the Provinces mandatorily was the income tax, for which purpose, the relevant provisions were contained in section 138 of the Act which read, inter alia, as follows:
"138.(1) Taxes on income other than agricultural income shall be levied and collected by the Federation, but a prescribed percentage of the net proceeds in any financial year of any such tax, except in so far as those proceeds represent proceeds attributable to Chief Commissioner's Provinces or to taxes payable in respect of Federal emoluments, shall not form part of the revenues of the Federation, but shall be assigned to the Provinces and to the Federated States, if any, within which that tax is leviable in that year, and shall be distributed among the Provinces and those States in such manner and from such time as may be prescribed."
Despite the statutory provisions contained in the GOI Act, 1935 for mandatory sharing of the net proceeds of income tax with the Provinces, the determination of the exact percentage of the net proceeds that was to be shared (vertical sharing) as well the issue of inter se sharing among the Provinces, had been left to be prescribed separately by the His Majesty in Council, i.e. the Federal Government, who appointed a committee under the chairmanship of Sir Otto Niemeyer to make recommendation in the matter. Sir Niemeyer considered the necessity of safeguarding the financial stability of the Centre and the obvious future needs of the provinces and in order to maintain a reasonable adjustment of relative burdens between the various units, recommended that 50 per cent of the net proceeds of income tax, excluding those proceeds that were attributable to Chief Commissioner's Provinces or to taxes payable in respect of Federal emoluments, should be assigned to the provinces. This was accepted by the then Government of India and was continued to be observed till the end of the British rule and for a few years after India became independent, i.e. up to 31st March, 1950. As for the horizontal distribution, Sir Niemeyer recommended a mix of the factors of residence (i.e. source of revenue collection) and population of the province, giving the two factors equal weight.
In respect of the Central Excise Duties, section 140 of the GOI Act, 1935 provided for sharing of the same with the Provinces and the Federated States only if the Federal Legislature provided for such sharing by enacting a legislation for the purpose. This section is partly quoted below:
'140.(1) Duties on salt, Federal duties of excise and export duties shall be levied and collected by the Federation, but, if an Act of the Federal Legislature so provides, there shall be paid out of the revenues of the Federation to the Provinces and the Federated States, if any, to which the Act imposing the duty extends, sums equivalent to the whole or any part of the net proceeds of that duty, and those sums shall be distributed among the Provinces and those States in accordance with such principles of distribution as may be formulated by the Act.'
Such legislation was, however, never enacted and during the entire period of British Rule, the Central Excise Duties were not shared with the Provinces.
The period 1947-1950
During the period commencing with the independence and till the promulgation of the Constitution in 1950, the principles being followed till 1947 for distribution of income tax receipts, based upon the Niemeyer Award, were broadly continued. For the inter se sharing of the divisible share of income tax, the Government of India took an executive decision in regard to the shares attributable to the divided parts of the provinces of Punjab and Bengal as well as the North-West Frontier Province that had gone to the newly created Pakistan. The provincial shares were revised after distributing the quota of such transferred territories among the provinces of the Indian Union according to population with some adjustments in favour of West Bengal and Assam.
Integration of the Princely States into the Indian Union had revenue implications on the receipt as well as expenditure side, as the Centre took over some of the sources of revenue receipts, such as the income tax, as also the expenditure responsibilities of the subjects falling in the Union List of the Seventh Schedule. To examine these issues, the Indian States Finances Enquiry Committee was set up in October 1948 with Shri V.T. Krishnamachari as chairman, with primary focus for the Part B States as well as of Baroda's merger with Bombay. The report of the Committee was discussed by the Government of India with the States concerned and with certain agreed modifications, incorporated in the agreements entered into by the Government of India with the States.
The main feature of the agreements between the Government of India and the States was that the Centre would make good the difference between the loss of revenue and savings on expenditure responsibilities, for a transitional period, as 'revenue gap grants'. For this purpose, the revenue receipts and expenditure figures were determined based upon an agreed period immediately preceding the integration. The revenue gap grants were guaranteed in full for the first five years and on a gradually diminishing scale for a further period of five years at the end of which the grants would reach the level of approximately sixty per cent of the original figure. It was also agreed that the States would get either a share in divisible sources of revenue like the income tax, or the 'revenue gap grant', whichever would be higher. It was also agreed that the share of each State should be 50 per cent of the net proceeds of the taxes on income other than agricultural income levied and collected by the Government of India in that State in each year. The issue of financial burden caused to some of the States by merger of the former Princely States with them was also addressed. It was provided that all such States affected by the merger would receive 50 per cent of the net proceeds of the taxes on income other than agricultural income levied and collected in the merged territories within the State each year or the 'revenue gap grant', whichever would be higher. This arrangement led to provision of 'revenue gap grant' to four Part A States, namely, Bombay, Bihar, Madhya Pradesh and West Bengal.
The President of the Constituent Assembly had, in the mean while, referred the issue of financial provisions to be incorporated in the Constitution that was being drafted, to an expert committee headed by Shri R.N. Sarker. The Committee made various suggestions including the setting up of a Finance Commission for making recommendations relating to fiscal transfers and sharing. The suggestions of the Committee were discussed in the Constituent Assembly and were incorporated in the Constitution after some amendments.
Enactment of the Constitution in 1950
Constitutional provisions relating to distribution of revenues between the Union and the States were governed mainly by articles 268 to 281 of the Constitution. These provisions prescribed the Union taxes into four broad categories, namely,-
a. Duties levied by the Union but collected and appropriated by the States (article 268). These included certain stamp duties and duties of excise on medicinal and toilet preparations.
b. Taxes levied and collected by the Union but assigned to the States (article 269). These included succession and estate duties on non-agricultural properties, taxes on railway fares and freights, taxes on inter-State sale, purchase on consignment of goods, etc.
c. Taxes levied and collected by the Union and distributed between the Union and the States (article 270). This included taxes on income other than agricultural income.
d. Taxes levied and collected by the Union but which could be shared with the States if Parliament so decided (article 272). This included Union duties of excise other than on medicinal and toilet preparations.
e. Taxes that were not sharable. The surcharge and cesses on Union taxes (article 271) and the remaining Union taxes, principally, the corporation tax, custom duties and taxes levied under residuary provisions, fall in this category.
Principles for sharing of receipts from income tax: In the Constitution of 1950, income tax sharing was mandatory, but with the following limitations:
a. Only the net proceeds of the receipts from the tax were sharable. The term net proceeds was defined in article 279, to mean exclusion of the cost of collection.
b. Taxes on the salary and pension related payments out of Union Budget, were to be excluded.
c. A share was to be prescribed as attributable to the Union territories.
d. After deducting for the above three items, the ratio of sharing between the Centre and the States was to be prescribed
e. The inter se shares of the various States was to be prescribed.
Details in respect of the first two of the above mentioned five items were to be provided by the Comptroller & Auditor general of India, whereas the remaining three items were to be prescribed by the President of India after considering the recommendations of the Finance Commission.
Principles for sharing of receipts from Union excise duties: Article 272 of the Constitution of 1950 provided for the procedure in respect of sharing of the net proceeds of the Union duties of excise other than on medicinal and toilet preparations, if Parliament decides for such sharing, by law. For doing so, the President had to obtain recommendation of the Finance Commission and after considering the same, cause a proposal to be placed before the Parliament.
Principles for sharing of receipts from the levies under articles 268 and 269: Levies under article 268 of the Constitution of 1950 included certain stamp duties and duties of excise on medicinal and toilet preparations. As these were to be collected and appropriated by the States themselves, the question of sharing did not arise. However, in respect of the levies article 269, the collections were to be made by the Government of India, but the entire net proceeds were to be assigned to the States and the principles for determining the share of each State were to be laid down by law by the Parliament upon recommendations in the matter by the Finance Commission.
The period 1950-1952: Deshmukh Award
While the Constitutional provisions relating to federal fiscal transfers were brought into force with effect from 26th January, 1950, an interim arrangement was followed by the Government of India till 31st March, 1952 when the decision in pursuance to the Award of the First Finance Commission came into force. During this period, i.e., till 31st March, 1952, the arrangements followed till then, which were in turn broadly on the lines of the Niemeyer Scheme, were continued. Accordingly, fifty per cent of the net proceeds of income tax, exclusive of the proceeds attributable to Part C States and the proceeds of the taxes payable in respect of Union emoluments, was assigned to the States. As for the horizontal transfers, a need was felt to make certain interim arrangements, to take care of the situation arising out of the partition of India that had led to transfer of some of provinces (or parts) to Pakistan and the share of such provinces (or parts) was to be redistributed among the Indian States.
To address these issues, a committee under the chairmanship of Shri C.D. Deshmukh was constituted towards end of 1949 to examine the matter and make suitable recommendations. Mr Deshmukh, in his report, recommended for redistribution of the aggregate quota available for redistribution largely on the basis of population, with two adjustments, one for the purposes of rounding off and the other for giving a small weightage in favour of the weaker States. The inter se share of the Provinces under the Deshmukh Award was as follows:
Province Inter se share (per cent)
Under GOI Scheme Under Deshmukh Award
1. Madras 18 17.5
2. Bombay 21 21.0
3. West Bengal 12 13.5
4. Uttar Pradesh 19 18.0
5. Madhya Pradesh 6 6.0
6. Punjab 5 5.5
7. Bihar 13 12.5
8. Orissa 3 3.0
9. Assam 3 3.0
Total 100 100.0
The Deshmukh Award was not expected to deal with the matter of sharing of Union duties of excise, nor did it deal with that matter. The Award was accepted by the Government of India and remained the basis for distribution of the sharable portion of income tax receipts from 1st April, 1950 till 31st March, 1952, whereafter the scheme pursuant to the recommendations of the Finance Commission came into force.
Constitution of the Finance Commission:
At the time of bringing into effect the Constitutional provisions relating to taxation and tax sharing, the Centre was levying and collecting four major taxes, namely, the income tax (IT) on the income of individuals other than agricultural income, corporation tax (CT), which is tax on the income of the corporate entities, Union Excise Duties (UED) and the Custom Duties (CD). In the context of tax sharing arrangements, these, as well as all other taxes levied by the Centre could be classified into three categories, namely:
a. Taxes that were subject to mandatory sharing with the States;
b. Taxes that were to be shared at the discretion of the Federal Legislature, the Parliament; and
c. Taxes that were precluded from being shared with the States.
The task of making recommendations on the vertical and horizontal transfers in respect of the first two category of taxes was assigned to the Finance Commission (FC), to be constituted by the President of India at an interval of five years or earlier under the provisions of article 280 of the Constitution. The FC is an expert body comprising a Chairman and four other members. The qualifications requisite for appointment as Chairman and member of the FC are governed by the provisions of the Finance Commission (Miscellaneous Provisions) Act, 1951, which was enacted by the Parliament in the year 1951. The Chairman is expected to be a person having experience in public affairs, whereas the other four members are to be either a serving/retired or qualified to be appointed as Judge of a High Court, or having special knowledge of the finances and accounts of the Government, or having wide experience in financial matters, or having special knowledge of economics. So far, eleven FCs have been submitted their reports, covering the period from 1st April, 1952 up to 31st March, 2005. The Twelfth FC is currently in the process of drafting its recommendations that would cover the period from 1st April, 2005 to 31st March, 2010. The effective duration of the Awards of earlier Finance Commissions has been as follows:
Finance Commission Period of Award
Ninth (1st Report) 1989-90
Ninth (2nd Report) 1990-95
The President of India constitutes each FC and appoints its Chairman and Members by way of formal orders. In that order, the President lays down the terms of reference (TOR) for the FC, which are in broad consonance with the duties for the FC prescribed in article 280 of the Constitution. Usually, however, the TOR prescribed in the Presidential Order is a bit more elaborate than those enlisted in the Constitution.
The Constitution allows the FCs to follow their own procedure. FCs have been empowered by law as a court to summon records and individuals that they deem necessary for their analysis. In practice, the FCs follow an elaborate methodology, which includes the following:
a. Compiling and analysing the past trends in receipt and expenditure of the Central as well as the various State Governments;
b. Obtaining detailed memoranda from various State Governments as well as the Ministries of the Central Government on the issues contained in the terms of reference for the FC.
c. Interacting with various stakeholders such as the academics, representatives of various political parties and interest groups;
d. Inviting suggestions from the general public; and
e. Discussions with the establishment of the Comptroller and Auditor General of India, besides examining his reports on the audit of accounts of the Central as well as the various State Governments and the commercial undertakings of those governments.
After examining the past track of the revenue receipts and expenditure of the Central and the various State Governments, the FC prepares a normative approach to assessing the projected revenue receipts and expenditure needs of the various governments, leading finally to its recommendations for resource transfers.
Devolution in respect of income tax proceeds
The successive Finance Commission had in regard to income tax dealt with the following three principal issues:
a. The percentage of net proceeds of income tax to be assigned to the States (vertical sharing);
b. The inter se distribution among the States (horizontal distribution); and
c. The percentage of net proceeds which shall represent proceeds attributable to the Union territories.
In respect of the last one of the above mentioned issues, it would be sufficient to say that the successive Finance Commissions had generally determined the ratio for the Union territories by treating all of them together in one group and applying the same norms as applicable for the States. The major attention of the FCs had been devoted to the crucial task of handling the other two issues. In respect of the Union duties of excise, the Constitution empowered the Finance Commission to make recommendation in regard to vertical as well as horizontal sharing, but it was left for the parliament to take a view. In making such recommendation, the FC was not required to set apart any share for the Union territories, though it had to work out the cost of collection so as to determine the 'net proceeds'.
First Finance Commission (1952-57)
The First FC, whose Award became effective from 1952, had to make its recommendations on tax sharing in the backdrop of the arrangements prevailing during the period 1947 to 1952. The arrangements for tax sharing during those five years were in essence the same as were followed during the immediately preceding period of the British Rule under the Government of India Act of 1935 and the Award of Sir Otto Niemeyer, which meant sharing with the States fifty per cent of the net proceeds of the taxes on income other than on agricultural income. For inter se distribution of the sharable amount among the States, the practice followed under the Niemeyer Award was a ratio developed on the basis of source of collection as well as population, giving equal weight to the two. During the period that immediately followed the independence and up to the commencement of the period of the Award of the First FC, i.e. 1947 to 1952, the principles adopted under the Niemeyer Scheme were continued, as an ad hoc arrangement, for both vertical sharing as well as horizontal distribution.
The First FC had, on the one hand, to keep the past tradition of income tax sharing in view, it also had to, on the other hand, take into consideration the plea of several State Governments for transfer of a higher share of income tax proceeds in favour of the States. On balance, the FC decided to recommend for transfer of 55 per cent of the net proceeds of the taxes on income other than on agricultural income, to the States. On the issue of inter se distribution of the States' share among the various States, a legal factor was raised before the First FC, that is, whether a State wherein income tax was not leviable, would receive a share of the distributable net proceeds of the tax, a case in point being the State of Jammu & Kashmir in which territory income tax was not leviable. The First FC took the view in the negative and this view was upheld and followed by the succeeding FCs as well. Having settled this point of order, the First FC proceeded to examine the matter further. The principles to be considered for the inter se distribution were (a) the source of collection and (b) population. Some of the States, particularly those which housed many corporate headquarters and commercial and industrial enterprises, had sought for a high weightage for the factor of source of collection. Some of these States, such as West Bengal, went to the extent of interpreting the term 'leviable' to mean and imply 'source of collection'. However, the Finance Commission took the view that tax share was required by the States more for meeting their expenditure responsibilities than for obtaining a legal right in terms of 'leviable tax' etc. The Commission also considered as significant the issue of equity in the matter of tax sharing among the States and felt that equity would be achieved far more through the factor of population. On such grounds, the Finance Commission adopted a formula for inter se sharing of income tax receipts which gave 20 per cent weight to the source of collection and 80 per cent to the population of the States as per the Census of 1951
On the issue of sharing of the proceeds of Union excise duties (UED), it may be recalled that the GOI Act of 1935 had made it optional for the Federal Legislature to do so by law. However, no such law was made and the UED revenues were never shared with the Provinces in the British India under the GOI Act of 1935 right up to 1947. The power to levy excise duties on intoxicating liquors an on opium were assigned to the States under the GOI Act of 1935 as well as under the Constitution of 1950. at the time when the First FC was finalising its Award, UEDs were levied on twelve major commodities including sugar, tobacco, textiles, matches, steel ingots, kerosene, petrol, pneumatic tyres and tubes, vegetable products, tea and coffee, yielding an annual revenue of about Rs.85 crore in the year 1951-52. States, in their memoranda to the Finance Commission, had sought for transfer of the UED proceeds to varying measures and some States had sought for the entire proceeds of UED to be transferred to the States. The Commission felt that while it was desirable to share the UED proceeds with the States, but such sharing should be limited to only those commodities that were of common and widespread consumption and yielded significant revenue. On these premises, the Commission recommended that 40 per cent of the net proceeds of UED from three commodities, namely, tobacco (including cigarettes etc.), matches and vegetable products should be allocated to the States.
For the horizontal distribution of the sharable proceeds of UED, States had made varied proposals before the First FC, some had sought for contribution, population, area and consumption to be given weight, in varying degrees. The Commission felt that data on consumption was not available and on this ground, this factor could not be given weight. The Commission did not agree to give weight to other suggested criteria, except for population, on the stated grounds that the scheme of sharing needed to be stable, balanced and equitable. Finally, the Commission recommended distribution of the sharable proceeds of the UED among the States on per capita basis.
Second Finance Commission (1957-62)
For the Second Finance Commission, States made varied propositions in respect of distribution of income tax proceeds. For the vertical distribution, States in general sought for a substantial increase from the prevailing ratio of 55 per cent under the Award of the First FC. The Commission appreciated the plea of the States and raised the quota of net proceeds of income tax to be shared with the States from 55 per cent to 60 per cent. As for the inter se sharing, the views of the States varied from giving hundred per cent weight to the source of collection (West Bengal), hundred per cent to population (Andhra Pradesh, Bihar, Kerala, Madras, and Uttar Pradesh), and to a mix of the two criteria. Some States also sought for giving weight to the factors of area, backwardness, share of the scheduled castes and scheduled tribes in the population, etc. The Commission felt that income tax was being paid only by an infinitesimal portion of population and that the bulk of the tax arose out of business incomes which, in the context of the economic integration of the country and the disappearance of barriers to inter-state trade, was derived from the country as a whole and, accordingly, the principle of source of collection could not be considered an equitable basis of distribution. The Commission favoured distribution of the sharable quantum of income tax receipts among the States entirely basing on population. However, with a view to avoid a sudden break in continuity, it finally mooted 10 per cent weight for the source of collection and 90 per cent for population (1951 Census), with the expectation that in due course the 'source' factor would get eliminated and the entire sharing would be on population basis alone.
The Union excise duties were placed by the Constitution in the category of optional sharing, subject to a law made by the Parliament. Based upon the recommendations of the First FC, Parliament enacted the Union Duties of Excise (Distribution) Act, 1953, to provide for sharing of 40 per cent of the net proceeds UED from tobacco (including tobacco products), matches and vegetable products, with the States. Subsequent FCs continued to follow the concept of sharing of the UED collections, but with changes in the basket of commodities and the percentage to be shared. Over the years, increasing number of commodities were brought into the purview of excise taxation, making the UED a buoyant source of revenue and motivating the States to seek an increasing share of the same. The Second FC noted that the number of commodities covered for the levy of UED was thirteen yielding a revenue of Rs.83.03 crore, whereas for 1957-58, the number had risen to twenty-nine and the yield, to Rs.259.57 crore. Many States sought before the FC for inclusion of more and more number of taxable commodities in the base for sharing, some seeking for all. The Commission met the demand of the States partially and raised the sharable base for UED to, besides the three commodities included by the First FC, five more, namely, sugar, tea, coffee, paper, and vegetable non-essential oils. Keeping the widened tax base mooted for sharing, the Commission reduced the percentage for vertical sharing to 25. As for the inter se distribution among the States, the Commission felt that consumption was not a desirable base as high consuming States were the richer States who would also be getting higher receipts from their own taxes such as sales taxes on such consumption. On such considerations, the Commission felt inclined to recommend population as the sole criterion, but finally decided to give 90 per cent weight to population leaving the remaining 10 per cent for making 'adjustments' in favour of such States that would face disadvantage on account of the large weight being given to population. The Commission did not explicitly indicate either the principles or the State-wise figures adopted by it for making such adjustments.
Third Finance Commission(1962-66)
The Third Finance Commission noted the plea of the States that as per the Finance Act, 1959, the income tax paid by the companies was classified as corporation tax and was thus excluded from the pool of the distributable proceeds of income tax, leading to shrinkage of the divisible pool. On this ground, the Commission raised the percentage of the divisible pool to 66-2/3 per cent. As for the inter se distribution of the distributable share of income tax receipts, the Third FC restored the weight of 20 per cent to the factor of collection given by the First FC, on the grounds that this would provide incentive and wherewithal to the States to maintain the environment which would promote and preserve industrial and trade activities. Another reason for such restoration cited by the Third FC was the fact that after the Second FC had made its Award, the taxes on income paid by the companies was excluded from the divisible pool, which took out the element of concentrated sources of collection. With these arguments in view, the Third Commission restored the weight of 20 and 80 to collection and population, respectively, that was assigned by the First FC.
The Third Finance Commission also noted that the range and depth of the coverage of commodities under the UED was ever expanding. The revenue yield from this tax had gone up from the level of about Rs.85 crore in the year 1951-52 to Rs.383 crore in the year 1960-61, making it a good source of revenue for meeting the fiscal needs of the Centre and States. Accordingly, it recommended to include the excise duties collected on all the commodities in the base year (1960-61), with some exceptions. To remove any ambiguity, the Commission listed out the commodities the excise duties on which would be liable for sharing with the States. With such broadened base, it recommended the share for transfer to States to be fixed at 20 per cent of the net proceeds of the Union excise duties. However, while the Commission was so specific in terms of principles for vertical sharing, it was rather opaque in expounding the ratios that it prescribed for horizontal sharing. It indeed explained its mind in the matter by stating thus: 'We consider that while population should continue to be the major factor of distribution, the relative financial weaknesses of the States, the disparity in the levels of development reached, the percentage of scheduled castes and tribes and backward classes in their population, etc. should also be taken into account in determining the share to be allocated to each State individually. In other words, we feel that in this permissive participation, an attempt should be made to bring all the States, as far as possible, to a comparable level of financial balance.' Having stated as above, the Commission proceeded to indicate the specific ratios for each State without specifying the specific figures for the various factors that it used to arrive at those numbers.
In the absence of the details of the basis adopted by the Third FC to determine each State's share in the sharable quota of the UED, the best possible indicator to study the same is the exact figures of percentage for each State recommended by it and compare the same to the corresponding figures recommended by the Second FC, which are as follows:
Inter se share of States in Union Excise Duties (%)
State Second FC Third FC
1. Andhra Pradesh 9.38 8.23
2. Assam 3.46 4.73
3. Bihar 10.57 11.56
4. Bombay* 12.17 12.18
5. Jammu & Kashmir 1.75 2.02
6. Kerala 3.84 5.46
7. Madhya Pradesh 7.46 8.46
8. Madras 7.56 6.08
9. Mysore 6.52 5.82
10. Orissa 4.46 7.07
11. Punjab 4.59 6.71
12. Rajasthan 4.71 5.93
13. Uttar Pradesh 15.94 10.68
14. West Bengal 7.59 5.07
Total 100.00 100.00
*For Third FC, Bombay was in two parts, Gujarat (6.45) and Maharashtra (5.73).
It is obvious that the principles adopted by the Third FC for horizontal distribution of UED proceeds meant a serious impact on some of the States.
Fourth Finance Commission (1966-69)
State Governments, in their submission before the Fourth and subsequent Finance Commissions, had been consistently demanding for sharing of still higher percentage of both income tax and Union duties of excise. Among the various grounds raised by the States for seeking progressively higher share in the Union levies was the argument that States had to incur committed expenditure on the plan schemes, which stood transferred to the States upon commissioning or upon completion of the five-year plan period. In pursuit of this quest, some States were seeking to include the remaining major Union taxes, namely, the corporation tax and the custom duties, also in the divisible pool by way of the required amendment to the Constitution. While fructification of the last mentioned demand of the States, i.e. inclusion of the corporation tax and the custom duties in the divisible pool , had to wait for a long time, the remaining demands of the States were met in a gradual fashion in the awards of the FCs. The Fourth FC raised the share of income tax proceeds for vertical transfer to the States to 75 per cent.
For horizontal distribution of the sharable quota of income tax among the States, the Fourth FC felt that factors such as area, backwardness, financial weakness, proportion of the population of scheduled castes and tribes, as were sought to be considered by some States, were not the proper ones. With that, the Commission felt that population and collection were the only satisfactory criteria for this purpose. For giving relative weight to these two factors, the Commission decided to retain the ratio mooted by the First and the Third Commissions, namely, 80 and 20 per cent, respectively.
In respect of the Union duties of excise, States not only sought for higher shares in the scheme of vertical transfers, but also sought to include the special excise duties that were introduced in the year 1963 in the context of the National Emergency. For the first issue, namely, enhancement of the percentage of the net proceeds of UED for transfer, the Fourth FC did not make any change, retaining it at 20 per cent. However, the Commission expanded the base of the tax available for sharing by recommending to include all commodities without any exception as were introduced by the preceding Finance Commission. The Commission also felt that there was no legal bar for it in recommending for sharing of the proceeds of the special duties as well, but it refrained from doing so on the consideration that these special duties were levied to meet a specific purpose of the Union Government. At the same time, the Commission expressed hope that special duties would be levied as an exception rather than a rule.
The issue of changes in the formula for inter se sharing of the sharable kitty of the UED among the States, the Fourth FC felt that the factor of 'consumption' or 'contribution' as sought by some States, was not feasible for consideration as no reliable data on consumption by States was available. The Commission was appreciative of the argument of some of the States that sharing of UED being not mandatory, should be based on the needs of the respective States. However, it felt that population was a good, though not sole, indicator of the needs of a State. The other indicator for the needs would be the social and economic backwardness, for which it considered seven factors, namely, per capita gross value of agricultural production, per capita value added by manufacture, percentage of workers to total population, school enrolment ratio, population per hospital bed, ratio of rural population, and ratio of scheduled castes and tribes to the total population, without however indicating the exact manner in which these factors would be combined. With these factors as the base, the Commission gave a weight of 80 per cent to the population and 20 per cent to the social and economic backwardness.
Fifth Finance Commission (1969-74)
The Fifth Finance Commission was given an additional term of reference, to make recommendation on the advance collection of income tax. As per the extant practice, the advance tax receipts were not considered for devolution until completion of the regular assessment of the respective tax returns. The commission consulted the Comptroller & Auditor General of India, Government of India and the State Governments, and recommended to change the practice and to add the advance tax collections into the distributable pool for the year of collection. The amount of net proceeds of advance collection of income tax involved in the matter was as high as Rs.371.12 crore, which included the collections for past several years for which final assessment was yet to be completed. The Commission felt that it would be difficult for the Government of India to shell out 75 per cent of this amount in one go, particularly as the money was received over past several year, it recommended that States' share in the same should be released in three equal annual instalments.
All along, the States had been seeking a higher percentage for devolution of income tax proceeds, which, as we saw above, was raised by the successive Finance Commissions, from 50 percent in the pre-First FC period, to 55 per cent by the First FC, 60 per cent by the Second FC, 66 2/3 per cent by the Third FC, and 75 per cent by the Fourth FC. While considering the demand of the States in the matter, the Third FC had observed that:
'In the case of divisible tax in which there is obligatory participation between the Union and the States, a sound maxim to adopt would be that all participating Governments, more particularly the one responsible for levy and collection, should have a significant interest in the yield of that tax.'
These observations of the Third FC were appreciated by the Fifth FC too. The Fifth FC also felt that States had been given additional devolution out of the advance collections of income tax relating to past several years, and on such considerations, it recommended to retain the level of devolution in respect of the net proceeds of income tax (vertical share) to the level recommended by the Fourth FC, i.e. 75 per cent.
Towards the issue of sharing of the income tax proceeds among the States, the Fifth FC was inclined to give a high weight to the factor of population, citing the '------- broader considerations of equity and the main purpose of devolution, which is to secure a more balanced correspondence between needs and resources of States in widely different circumstances'. On the factor of 'contribution', i.e., the source of collection of income tax, the Commission was of the view that the place of collection was often determined by convenience of the assessee without reference to origin of incomes. With these considerations in view, the Commission reduced the weight to the factor of 'collection' to 10 per cent and correspondingly enhanced that for population to 90 per cent.
States had represented to the Fourth as well the Fifth FC seeking a share in the special excise duties too, at par with the basic duty. The Fourth FC had declined this request on the grounds that the special duties were levied in the special context of the National Emergency. The Fifth FC noted that the special duties had continued for more than six year and, therefore, had assumed the character of basic duty. It also recalled that it had recommended for an extra share for the States in respect of income tax, by way of sharing the advance tax collections relating to past several years that were yet to be finally assessed, to be released to the States in three annual instalments. Keeping these factors in view, the Fifth FC recommended that the special excise duties should also form part of the sharable proceeds at par with the basic duty, but after a lapse of three years, i.e. from 1972-73, provided, however, such special duties continued to be levied. With this recommendation in the background, the Commission recommended that the vertical share for the States in the divisible proceeds of UED be retained at the level recommended by the preceding FC, i.e. 20 per cent.
For inter se sharing of the sharable proceeds of the UED, the Fifth FC considered the various options mooted by the States such as consumption, population, economic and social backwardness etc. It ruled out the factor of 'consumption' as it would be in favour of the more urbanised and developed States that would anyway be mobilising higher resources from own taxes etc., the same argument which was taken by the Second FC. The Fifth FC went on to add that:
'In considering this question of distribution among the States it is necessary to keep in mind the main purpose of devolution, which is to augment the resources of States in an equitable manner to enable them to meet their growing needs. Such needs depend mainly on the size of the States' populations, their relative income and resources and their levels of economic development.'
On the above considerations, the Fifth FC felt it appropriate to recommend that the sharing of the sharable proceeds of UED among the States should be based to the extent of 80 per cent on the population of the respective States, 13 1/3 per cent on the distance of the State's per capita income (PCI) from the average of the PCIs of all States and the remaining 6 2/3 per cent on the index of backwardness of the respective States. The Commission developed the index of backwardness as a combination of six factors, namely, the scheduled tribe population, number of factory workers per lakh of population, net irrigated area per cultivator, length of railways and surfaced roads per 100 square kilometres, school enrolment ratio, and the number of hospital beds per 1000 population.
Sixth Finance Commission (1974-79)
The Sixth Finance Commission, in determining the ratio for devolution of income tax proceeds for the States, mainly considered two factors: one, that the Union surcharge in the income tax had been not only continued almost on a permanent basis but had even been enhanced from 10 to 15 per cent in 1971-72, and two, the additional receipts awarded by the Fifth FC to the States on account of sharing the advance tax collections relating to past several years, had been over. Keeping these factors in view, the Commission recommended to increase the ratio of States' share in the divisible proceeds of income tax, to an all time high level of 80 per cent. As for the sharing among the States, the Commission decided to continue with the formula adopted by the previous FC in recommending 10 per cent weight for the factor of collection and 90 per cent for population.
In respect of sharing of Union duties of excise, States, in their plea before the Sixth Finance Commission, had sought for enhancement in the ratio for vertical sharing. However, the Commission felt that enlargement of the divisible pool would confer disproportionately larger benefit on surplus States than on the deficit States. Keeping such considerations in view, the Commission retained the ratio for vertical sharing at 20 per cent. In the mean time, Parliament had introduced auxiliary duties on excisable goods by way of the Finance Act, 1973 which specifically laid down that these auxiliary duties were levied for the purposes of the Union and shall not be sharable with the States. In their submissions before the Sixth FC, States objected to such exclusions stating that these auxiliary duties were in pith and substance indistinguishable from the basic excise duties. The Commission appreciated this argument but felt it appropriate to give some time to the Centre in the matter and recommended that the net proceeds from the auxiliary duties of excise should be sharable, at par with the basic duties, effective 1976-77 onwards. As regards the horizontal distribution among the States, the Commission felt that the weight for backwardness should be enhanced to 25 per cent, measured in terms of distance of the per capita income (PCI) of a State from that of the State with highest PCI, multiplied by the population, leaving the weight for population to be 75 per cent.
Seventh Finance Commission (1979-84)
While examining the fundamentals of the concepts of tax devolution vis-à-vis grants-in-aid to the revenues of the States, the Seventh Finance Commission was of the view that 'the grants-in-aid element in the transfer scheme should as far as possible be a residual item and attempt should be made to make the bulk of the transfers through tax shares'.
In dealing with the sharing of the net proceeds of income tax with the States, the Seventh Finance Commission observed that the surcharge element on the income tax had obtained the nature of a permanent levy and ought to be made sharable. However, as there was a specific Constitutional bar in sharing of surcharge with the States, the Commission recommended to raise the ratio of States' share to 85 per cent. As for the inter se distribution among the States, the Commission retained the ratios of 10 and 90 per cent to the factors of 'collection' and population, respectively, as was recommended by the preceding Finance Commission. Sikkim was excluded from receiving a share in this fund till such time as income tax continued to be not leviable in its territory.
Keeping in view its professed ideal of to make bulk of the transfers through the mechanism of tax sharing rather than grants-in-aid, the Seventh Finance Commission raised the States' share not only in the sharable proceeds of income tax to 85 per cent but also in the sharable proceeds of Union excise duties from the level of 40 per cent recommended by the preceding Commission to 40 per cent. As for the principles for inter se sharing of the UED proceeds, the Commission decided as a principle to work towards reduction of inter-State imbalances through a set of measures, but using population as a scaling factor. The set of measures adopted by the Commission for this purpose included four factors, namely, population, inverse of per capita State domestic product, percentage of population below the poverty line in the State and a formula for revenue equalisation, giving each factor a weight of 25 per cent. The formula for revenue equalisation mooted by the Commission was based upon computing the distance of the per capita revenue potential of each State, regressed on the average per capita income, from that of the highest per capita income States, i.e. Punjab, multiplied by the estimated population of the State as on the 1st of March 1976.
Eighth Finance Commission (1984-89)
The Eighth Finance Commission too felt the same way about the issue of surcharge on income tax as was observed by the Seventh FC. None the less, the Eighth FC retained the ratio of sharable proceeds of income tax to 85 per cent. As for the principles for inter State sharing, the Commission felt that the factor of 'contribution' should remain at 10 per cent whereas the remaining 90 per cent should be shared among the States on a formula that should be common in respect of both, income tax as well as Union duties of excise, i.e. 25 per cent to population, 25 per cent to the inverse of per capita income multiplied by the population and 50 per cent to the distance of per capita income.
In respect of the Union duties of excise, the Eighth Finance Commission too continued with the approach of the preceding FC that States' revenue deficit should be made good preferably by way of tax devolution than by way of grants-in-aid. The normative re-assessment of the States' revenue receipts and expenditure made by the Eighth FC indicated that out of twenty-two States, only six would be in surplus whereas the remaining would be in deficit, on revenue account. Therefore, the Commission while recommending to retain the level of vertical sharing of the sharable net proceeds of the UED to 40 per cent, recommended that another 5 per cent should be distributed among those States that remained in deficit even after taking into account the mooted share from income tax, 40 per cent of UED and other miscellaneous transfers under the FC Award, in proportion to such deficits. For determining the share of each State under the 40 per cent of the devolution amount out of the UED proceeds, the Commission mooted three factors, namely, population (1971 Census), the inverse of per capita income multiplied by the population (1971 Census) and the distance of per capita income (PCI) from that of the highest PCI State, i.e. Punjab. In order to avoid nil share for the State of Punjab under the 'distance' criterion, as had happened under the Awards of the Sixth FC in distributing 25 per cent of the States' share in UED on the basis of the 'distance' method or under the Awards of the Seventh FC in distributing 25 per cent of the States' share in UED on the basis of the equalisation factor, the Eighth FC gave a notional distance for Punjab.
Ninth Finance Commission (1989-95)
The Ninth Finance Commission was asked by the President to make two reports, the first report covering one year period of 1989-90 and the second report, five years, 1990-95. In the First Report (1989-90), the Ninth FC retained the ratios recommended by the Eighth FC for vertical sharing in respect of the proceeds of income tax and Union excise duties, i.e., 85 per cent for the income tax and 45 per cent for the UED. Of the latter, 40 per cent portion was to be distributed based upon a formula applicable uniformly to all the States whereas the remaining 5 per cent was to be distributed among those States that remained in deficit even after taking into account the mooted share from income tax, 40 per cent of UED and other miscellaneous transfers, other than grants-in-aid, under the FC Award. As for the horizontal distribution among the States, in respect of income tax, it retained the weight of 10 per cent for the factor of 'collection' and 90 per cent for backwardness. For distribution of this 90 per cent of the income tax share as well as for the '40 per cent sharable portion' of the UED, the Commission modified the formulation of the Eighth Commission slightly so as to give 25 per cent weight to population, 50 per cent to 'distance' from the highest per capita income State multiplied by the State's population, 12-1/2 per cent to the inverse of per capita income multiplied by the State's population (called the 'income adjusted total population' or, IATP), and 12-1/2 per cent to the BPL population.
The Ninth Finance Commission in its second report, retained the level of vertical transfers in respect of the sharable proceeds of income tax at 85 per cent, stating its unwillingness to raise the ratio any further. For inter se sharing of the same among the States, it retained all the factors and the respective weights except for one change, i.e. replacing the factor of below poverty line population by a composite index of backwardness developed by it, but retaining the weight for the same at 11.25 per cent. The Commission noted that it was giving up the factor of BPL ratio owing to lack of availability of adequate data for the purpose.
In respect of determination of States' share in the net proceeds of the Union excise duties, the Ninth Finance Commission in its second report, retained the level of vertical transfer to 45 per cent, as was recommended by it in the first report as well as by the Eighth FC, but, however, without segregating it into the ratio of 40 and 5 for general distribution and for post-devolution deficit States, respectively. As for the sharing of the same among the States, it retained some of the factors and the weight assigned in its first report, namely, 25 per cent weight to population, and 12.5 per cent weight to IATP, but reduced the weight for the 'distance' factor from 50 per cent to 33.5 per cent. The Commission recommended for distribution of the remaining 16.5 per cent among those States that remained in deficit on non-plan revenue account even after taking into account the mooted share from devolution of various taxes and duties including the share of UED to the extent of 83.5 per cent of the sharable proceeds and other miscellaneous transfers, other than grant-in-aid, under the FC Award, in proportion to such deficits.
Tenth Finance Commission (1995-2000)
The Tenth Finance Commission, in relation to the sharing of the proceeds of income tax with the States, recalled that the ratio which started with 55 per cent in the award of the First FC, had gone up to 85 per cent in the award of the Tenth FC. It relied on the dictum 'that the authority that levies and administers the tax should have a significant and tangible interest in its yield' and accordingly recommended to reduce the ratio to 77.5 per cent, while assuring at the same time that the loss to the States in this way would be made good by suitably enhancing their share in the Union excise duties. For the inter se sharing of the sharable amount of income tax receipts among the States, the Commission dropped the factor of 'contribution' or 'collection' mainly on the grounds that the generation of income was a spatially interdependent activity. It reduced the weight assigned to population to 20 per cent for two reasons, namely, population was not a progressive criterion and in any case, population being used for scaling the other factors, was reflected adequately in the distribution formula. The Commission also compared the influence of the inverse income formula with the 'distance' formula and found that under the former, owing to the implicit convexity in it, the middle income States had to bear a relatively higher burden of the adjustment, which might be interpreted as a deficiency of the inverse income formula. The Commission, therefore, decided to use the distance formula alone for bringing about progressivity in distribution, and assigned to it the weight of 60 per cent.
Besides population and 'distance' the Tenth FC included three more factors in the formula for inter se distribution of the sharable proceeds of the income tax receipts. These included the geographical area, on the grounds that larger area would imply additional administrative and other costs for the State, the index of social and economic infrastructure which was based on the 'distance' method, i.e. a State having lower level of infrastructure vis-à-vis the highest, gets a higher share, and, lastly, tax efforts of the State measured by the ratio of per capita own tax revenue to the square of per capita income. The Commission assigned to these three factors weight of 5, 5 and 10 per cent, respectively.
In respect of sharing of the Union duties of excise, the tenth Finance Commission decided to recommend for raising the States' share to 47.5 per cent, as against 45 per cent recommended by the preceding Commission, on the grounds that it was recommending a reduction in the ratio for sharing of the income tax proceeds. The Commission placed this figure of 47.5 into two parts, 40 and 7.5. The 40 per cent part was to be distributed among the States in terms of a uniform formula comprising the same 5 factors with the same weight as were mooted by it in respect of income tax sharing. The balance 7.5 per cent part was recommended for allocation among the was to be distributed among those States that remained in revenue deficit even after taking into account the mooted share from income tax, 40 per cent of UED and other miscellaneous transfers, other than the grants-in-aid, under the FC Award, in proportion to such deficit.
Alternative Scheme of Devolution: Many States had been pleading before the various Finance Commissions for making sharable all Union taxes and duties, more particularly the corporation tax and custom duties. The Finance Commissions had generally been sympathetic to this plea, with a view not only to provide psychological satisfaction to the States, but also to bring about a feeling of camaraderie and co-ownership between the Centre and the States in the matters of levy and yield of various Union taxes and duties. However, prior to the Tenth Finance Commission, all the Finance Commissions had refrained from making any positive recommendation in the matter mainly on the grounds of Constitutional limitations. As an alternative, the Finance Commissions had recommended progressively higher share in the divisible taxes, namely, the income tax and the Union excise duties. The Tenth Finance Commission finally broke the ground by recommending for making all Union taxes and duties as sharable, except for the Central sales tax and consignment tax, and for making suitable amendments to the Constitution for this purpose so as to give effect to this Alternative Scheme of Devolution with effect from 1st April, 1996. However, the required amendment to the Constitutional did not come about even till the end of the period of recommendation of the Tenth FC, i.e. till 31st March, 2000.
The Constitution was amended in June 2000 by way of the Eightieth Amendment, which substituted a new article for article 270 and omitted article 272. As per the newly inserted article 272, all taxes and duties referred to in the Union List, except for those referred to in articles 268 and 269, were made sharable with the States. The surcharge and cesses on the Union taxes and duties, levied for specific purposes, were also excluded from sharing with the States. The newly inserted article 270 read as follows:
'270.(1), All taxes and duties referred to in the Union List, except the duties and taxes referred to in articles 268 and 269, respectively, surcharge on taxes and duties referred to in article 271 and any cess levied for specific purposes under any law made by Parliament shall be levied and collected by the government of India and shall be distributed between the Union and the States in the manner prescribed in clause (2).
(2). Such percentage, as may be prescribed, of the net proceeds of any such tax or duty in any financial year shall not form part of the Consolidated Fund of India, but shall be assigned to the States within which that tax is leviable in that year, and shall be distributed among those States in such manner and from such time as may be prescribed in the manner prescribed in clause (3).
(3). In this article, "prescribed" means,-
(i) until a Finance Commission has been constituted, prescribed by the President by order, and
(ii) after a Finance Commission has been constituted, prescribed by the President by order after considering the recommendations of the Finance Commission.
This met the long pending demand of the States. It also gave a different hue and dimension to the report of the next FC, namely, the Eleventh FC, which was already in the process of working out its award.
Eleventh Finance Commission (2000-05)
The Eleventh Finance Commission had to consider mainly the collections from income tax, Union duties of excise, customs and corporation tax, besides the nascent service tax, the additional duties of excise and the grants in lieu of the withdrawn tax on railway passenger fares. The Commission examined the ratio of the tax shares received by the States out of the sharable levies to the total revenues mobilised by the Government of India through sharable as well as non sharable levies, except the duties and taxes referred to in articles 268 and 269, and found that these corresponded to a ratio of about 29 per cent, though the ratio varied from year to year. The Commission took note of the requirements of the Centre as well as of the States and recommended that the States' share in the pooled basket of the Union tax revenues be fixed at 29.5 per cent.
For determining the inter se share of States in the sharable proceeds, the Eleventh Finance Commission mooted a six fold criterion, that included population (weight: 10 per cent), income as per distance method (62.5 per cent), geographical area (7.5 per cent), index of infrastructure (7.5 per cent), tax effort (5 per cent), and fiscal discipline (7.5 per cent). The last mentioned factor was to be a measure of the ratio of a State's own revenue receipts to its total revenue expenditure, in relation to the same ratio for all States put together and measuring the same over two sets pf periods, viz., average of 1990-91 to 1992-93 and average of 1996-97 to 1998-99. The other factors were, by and large, based upon the formulation enunciated by the Tenth FC.
Summary and conclusion
The summary position for the principles mooted by the successive Finance Commissions in respect of devolution and distribution of income tax and Union duties of excise has been given in a tabular form at the end of this paper. The detailed analysis of the approaches adopted by the successive Finance Commissions presented above gives the trend, in respect of the income tax devolution, of a general increase in States' share, rising from the level of 55 per cent under the award of the First FC (1952-57) to 85 per cent under the award of the Seventh FC (1979-84), which level was continued till the award of the Ninth FC (1989-95), while the tenth FC (1995-2000) scaled it down to 77.5 per cent. The logic adopted by the successive FCs in increasing such ratio were, principally, the growing needs of the States in terms of committed plan expenditure etc. and the nearly sustained imposition of surcharge on the tax that was non-sharable. The logic behind scaling down the ratio by the Tenth FC, which was appreciated by some of the preceding FCs as well, was that leaving a near zero share for the Centre would make it lose interest in mobilising higher receipts.
As for the inter se sharing of the sharable quota of the income tax proceeds, some of the earlier FCs (First, Third and Fourth) gave as high as 20 per cent weight to the factor of 'source of collection', but this was reduced to 10 by the later FCs (Second and Fifth to Ninth-1st Report) and thereafter, this factor was dropped altogether. The reason for giving this factor some weight was partly historical, as the Niemeyer Award (1936-47), as also the fact that some of the federating States were, prior to integration, levying this tax and had surrendered their right to impose this levy in favour of the Centre. The argument against this factor was that economic activities leading to generation of income were inter regional in character and merely because an assessee files his tax returns in a State would not imply that his income was generated owing to the economic contribution or support of that State alone. Yet another argument against this factor has been the view that income tax sharing was to be on the grounds of equity. The arguments against carried increasing weight over the years, leading to finally giving up this factor completely. In fact, the view that income tax sharing was mainly to bring about equity among the States, led to the increasing weight assigned to the factors of social and economic backwardness, such as distance from the most prosperous State in terms of per capita income, inverse of per capita income adjusted to population, backwardness in terms of availability of infrastructure etc.
Determination of States' overall share in the net proceeds of the Union duties of excise (UED) was a pioneering recommendation of the First FC. It made a modest beginning, by recommending 40 per cent share from the UED receipts from three commodities alone. The Second FC enlarged the basket of sharable commodities to eight, and reduced the sharing percentage to 25. The Third FC enlarge the basket further and reduced the percentage to 20. The Fourth FC made the proceeds from all the excisable goods part of the sharable basket, retaining the ratio at 20. The Fifth and the Sixth FCs retained the ratio to the level of 20 but recommended that special and auxiliary duties, if these were to be continued further, should also be made sharable. The Seventh FC felt that the approach to bridge the revenue deficits of States should be met more through tax devolution than through grants-in-aid. With this theme, it enhanced the ratio of vertical sharing to 40. The subsequent FCs, till the Tenth, maintained the same logic and set apart a portion of the UED exclusively for the States which remained in deficit after the common tax sharing.
For inter se distribution of the excise duty proceeds, 'source' or 'consumption' was not acceptable to any of the FCs, as they uniformly felt that that would give undue advantage to the prosperous States which would any way be mobilising higher levels of realisation from their own taxation, such as sales taxes, on such consumption. Equity was a high consideration, if not the paramount one, for the FCs for inter se sharing of UED proceeds. To this end, the First FC gave population a weight of 100 per cent, whereas the subsequent FCs, up to the Sixth, gave it the weight of 75 to 80 per cent. The later FCs extended the concept of equity into the realm of progressivity, by not only according weight for the factors of social and economic backwardness, but also enhancing the weight over the period, reaching the level of around 75 per cent for the Seventh FC onwards. Recent FCs, notably the tenth and the Eleventh, gave a new dimension to the inter se sharing by assigning weight for tax efforts and fiscal discipline. However, the factors of backwardness have continued to dominate the inter se sharing formula in the awards of the recent FCs. This trend has continued with the Eleventh FC which was to deal with the devolution of all the Central taxes pursuant to the Eightieth Amendment.
All in all, the quest of the Finance Commissions, over the years, has been to bring about horizontal equity among the various States, in terms of social and economic parameters of growth and development, besides providing fiscal stability to the governments at the Centre as well as in the various States. The Finance Commissions have sought to achieve this end through the mechanism of fiscal transfers. For whatever extent the disparities have remained, perhaps the Finance Commissions could not be blamed. For, the dimensions of the factors and causes for social and economic imbalances are far too complex, and not always amenable to the fiscal discipline alone.