The Weakened financial capacity of States

Context- With various measures the Centre government has reduced of the fiscal resource capacity of the States.

What are the reasons of weakened fiscal capacity of States?

  1. Impact of Implementation of GST on States– Since implementation, the Goods and Services Tax appears to have reduced the resource-generating capacity of States and has contributed to worsening inter-State inequality
  2. Centre undermines fiscal capacity of States-
  3. Cutbacks in devolution – Centre has systematically cut the share of States in taxes raised by the Union government.
  • Between 2014-15 and 2019-20, the States got ₹7,97,549 crore less than what was projected by the Finance Commission.
  1. Shrinking of divisible pool- Centre has reduced the pool of funds to be shared with the States by shifting from taxes to cesses and surcharges.
  • The Constitution allows the Centre to levy cess and surcharge which the Centre need not share with state governments.
  • When taxes are replaced with cesses and surcharges, consumer pays the same price. But the Union government keeps more of that revenue and reduces the size of the divisible pool. As a result, the States lose out on their share.
  1. GST shortfall
  • The GST Compensation Act, 2017guaranteed States that they would be compensated for any loss of revenue in the first five years of GST implementation, until 2022, using a cess levied on sin and luxury goods.
  • However, the economic slowdown has pushed both GST and cess collections down over the last year, resulting in a 40% gap last year between the compensation paid and cess collected.
  1. Central grants are also likely to drop significantly this year.
  • For instance,₹31,570 crore was allocated as annual grants to Karnataka. Actual grants may be down to ₹17,372 crore.

What are the Impacts of colossal borrowing on States?

  • Repayment burden will overwhelm State budgets for several years.
  • Budget issue – After paying loans and interest, salaries and pensions, and establishment expenses, nothing left for development and welfare.
  • The fall in funds for development and welfare programmes will adversely impact-
  • The livelihoods of crores of Indians.
  • The economic growth potential cannot be fully realized.
  • Adverse consequences will be felt in per capita income, human resource development and poverty

Way forward-

  • The systematic weakening of States serves neither federalism nor national interest. Therefore, The Centre must take several steps to ensure an adequate flow of resources to states.
  • Centre must immediately clear all its pending dues to state governments.


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