Hindu Editorial Analysis : 6-September-2024
India’s financial structure faces a significant challenge known as Vertical Fiscal Imbalance (VFI). This issue highlights the disparities between the revenue-generating capabilities of the Union government and the expenditure responsibilities of the States. The 16th Finance Commission has a crucial opportunity to address these disparities and promote equitable federal relations.
Understanding Vertical Fiscal Imbalance (VFI)
VFI refers to the mismatch in revenue collection and expenditure responsibilities between the central and state governments.
- Expenditure Responsibilities: States are tasked with crucial public spending in areas like health, education, law enforcement, and social welfare.
- Revenue Collection: Despite these responsibilities, States struggle to generate adequate revenue compared to the Union government.
According to the 15th Finance Commission, States accounted for 61% of public expenditure while collecting only 38% of the revenue receipts, indicating a significant imbalance.
Reasons for Vertical Fiscal Imbalance (VFI)
Several factors contribute to VFI:
- Revenue Generation Disparity: The Union government collects broad-based taxes like personal income tax and corporate tax, generating substantial revenue. In contrast, States rely heavily on consumption taxes, which are less effective.
- Increased Expenditure Responsibilities: Over time, States have seen their expenditure responsibilities grow, especially in essential sectors. However, their ability to raise revenue has not kept pace, leading to a widening fiscal gap.
Financial Grants to States
To help mitigate this imbalance, the central government provides various financial aids:
- Finance Commission Grants: These are based on the recommendations of the Finance Commission, allocating a share of central taxes to States.
- Plan Grants: Allocated under specific central schemes aimed at health, education, and infrastructure.
- Discretionary Grants: These are provided at the Union government’s discretion, often for specific projects or emergencies.
Current Share of States
The 14th Finance Commission recommended increasing the tax devolution share to States from 32% to 42%. However, the 15th Finance Commission, led by N.K. Singh, adjusted this to 41% until 2026. Special States, like those in the northeast, receive 90% funding from the Union, while other States have a 60:40 funding ratio.
Challenges in Addressing VFI
Several challenges persist:
- Rising Expenditure Responsibilities: States face growing demands in critical sectors without corresponding revenue growth.
- Low Revenue Collection Capacity: States depend on indirect taxes, which are often less productive.
- Dependency on Central Grants: This reliance can limit States’ financial autonomy and create uncertainty.
- Bureaucratic Delays: The process for fund allocation can be slow and inefficient, hindering timely project implementation.
Steps to Combat VFI
To address VFI effectively, several measures are needed:
- Increase in Tax Devolution: States are advocating for an increase to 50% in tax devolution in the upcoming 16th Finance Commission to better align revenues with their responsibilities.
- Strengthening State Revenue Capacities: States should improve internal revenue generation by broadening the tax base and enhancing collection efficiency.
- Greater Fiscal Autonomy: More independence for States in managing finances would reduce reliance on central grants.
- Streamlining Central Assistance: Simplifying the process for grant disbursement can ensure States receive timely financial aid.
Why In News
India’s financial structure is marked by a Vertical Fiscal Imbalance (VFI) between the Union government and the States, which creates challenges in resource allocation and fiscal responsibility. The 16th Finance Commission has a crucial opportunity to address these fiscal disparities to ensure equitable federal relations, thereby fostering a more balanced and effective governance framework.
MCQs about Addressing Vertical Fiscal Imbalance in India
- What does Vertical Fiscal Imbalance (VFI) refer to in the context of India’s financial structure?
A. The discrepancy between the number of taxes collected by the Union and States
B. The mismatch in revenue collection and expenditure responsibilities between the Union government and the States
C. The balance of trade between India and other countries
D. The allocation of financial resources to rural and urban areas
- According to the 15th Finance Commission, what percentage of revenue expenditure do States contribute while only collecting a certain percentage of revenue receipts?
A. 50% and 25%
B. 61% and 38%
C. 70% and 30%
D. 40% and 20%
- Which of the following is NOT a type of financial assistance provided by the central government to States?
A. Finance Commission Grants
B. Plan Grants
C. Revenue Grants
D. Discretionary Grants
- What is one of the key challenges faced by States in addressing Vertical Fiscal Imbalance (VFI)?
A. High income tax collection
B. Rising expenditure responsibilities without matching revenue growth
C. Surplus revenue generation
D. Excessive reliance on direct taxes
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