The politics of grants: Does the Centre play favourites with states?

The latest Union Budget sparked controversy, with Opposition leaders accusing the Centre of playing favourites: selectively allocating funds to states that support the Bharatiya Janata Party-led National Democratic Alliance while neglecting others. Do these allegations hold water? India Today’s Data Intelligence Unit dug into the numbers to get to the bottom of this.

REVENUE VS SPENDING

States generate only one-third of the revenue but are responsible for nearly two-thirds of public spending, relying heavily on central transfers.

Types of Funds: Funds are distributed mainly through the devolution of central taxes and grants-in-aid.

Usage of Funds: While states have discretion over devolved taxes, grants are often tied to specific projects, such as health and education programmes.

WHY IT MATTERS: STAKES OF FISCAL FAIRNESS

The distribution of funds among states has always been controversial, often sparking debates about political bias and regional disparity, especially between southern and northern states. This time, the issue has taken a new direction. The BJP did not secure an outright majority for the first time in a decade and now relies on allies.

IN NUMBERS

Data from key states’ budget documents since 1990, analysed using indexing methods, reveals significant disparities in funding increases across Indian states.

Bihar leads with the most substantial increase, experiencing an over 112-fold rise in grants and an 82-fold rise in total funding since 1990. This surge likely results from targeted developmental policies and fiscal allocations to improve one of India’s historically underdeveloped regions.

Key southern states Andhra Pradesh and Karnataka also saw substantial increases but with different dynamics. Andhra Pradesh had a nearly 68-fold rise in grants and a 55-fold rise in total funding. On the other hand, Karnataka saw a 70-fold increase in tax revenues, indicating strong economic growth and improved tax collection. Both states benefited from India’s fiscal policies, reflecting their changing economic landscapes.

Kerala and Uttar Pradesh showed more balanced growth across grants, tax revenues, and total funding, with increases ranging from 52 to 94 times the 1990 levels. Uttar Pradesh, India’s most populous state, had a 94-fold increase in tax revenues and a 93-fold increase in total funding. Kerala, known for its advanced social indicators, also showed consistent growth.

The 15th Finance Commission recommended that states receive 41 per cent of the divisible pool of central taxes, known as vertical devolution. The allocation among the states, or horizontal devolution, is determined by various criteria, including population, income levels, and geographic factors. This system aims to balance resource distribution across diverse regions, ensuring that funds are allocated based on need and equity.

BIG PICTURE: CENTRAL VS STATE RESPONSIBILITIES

State governments in India spend 61 per cent of the total government budget but only generate 27 per cent of the total revenue, including taxes and other income. This means they rely on the central government to cover the gap between what they spend and what they earn.

The Indian Constitution permits the Centre to collect a broader range of taxes than state governments. However, it also mandates that state governments spend more on public services and responsibilities than the central government.

Each Finance Commission in India has recommended a percentage of the net proceeds the central government should share with the states, known as the “states’ share of central taxes.” For instance, the thirteenth, fourteenth, and fifteenth Finance Commissions suggested sharing 32, 42, and 41 per cent, respectively.

In addition to these shared taxes, the Centre provides states with additional funds through various means. Some of these are based on Finance Commission recommendations, such as grants under Articles 275 and 282, while others, like funds for central sector schemes and centrally sponsored schemes, are not. The key measure of fair distribution is whether the “states’ share of central taxes” aligns with the Finance Commission’s recommendations.

Experts like Pinaki Chakraborty, the Vice-Chairman of the Jaipur-based Institute for Development Studies, emphasise the structured nature of fund allocation mechanisms in India: “There are two aspects to fund allocation to the States. One is the constitutional framework, and the other is the priorities of the Union government. Around 70 per cent of the funds allocated to the States are based on the Finance Commission’s recommendations. The Finance Commission is a constitutional body, and the Union government has no discretion as far as the Finance Commission transfer is concerned. The remaining 30 per cent is based on central sector schemes and centrally sponsored schemes. These are also based on certain design and national priorities. They cannot be termed as discretionary and based on certain biases. One can always disagree about these schemes’ design, effectiveness, and relevance to a state context. But that does not mean these schemes are made to favour some states.”

COMPLEX TAX STRUCTURES: CESSES AND SURCHARGES

After 1950, “net proceeds” for state shares referred to the total tax collected minus the cost of collection. Initially, only specific taxes, such as income tax and some excise duties, were shared with the states, while corporation taxes and customs duties were not included. However, after 2000, cesses and surcharges were excluded from the “net proceeds” shared with states. This exclusion was made permanent by a constitutional amendment.

Experts note that the increase in cesses and surcharges began after the 2015–16 period, coinciding with the Fourteenth Finance Commission’s decision to increase the states’ share of net proceeds from 32 to 42 per cent. This change reduced the funds available to the central government.

Manish Gupta, Associate Professor at the National Institute of Public Finance and Policy, explained that “Asymmetric assignment of revenues and expenditure responsibilities between the Union and states in the Constitution results in vertical imbalance, with relatively more revenue sources being assigned to the Union Government and more expenditure responsibilities to the states. This imbalance is addressed through the transfer of resources in the form of tax devolution and grants from the Union to the states.”

FINANCIAL TRENDS OVER THE YEARS

The data shows a significant rise in the state’s share of central taxes and total transfers over the years. In 2010, states received Rs 164,832 crore from central taxes, and total transfers amounted to Rs 310,389 crore. By 2025, these figures are projected to increase dramatically, with states receiving Rs 1,247,211 crore from central taxes and total transfers reaching Rs 2,348,980 crore.

Finance Commission transfers, starting at Rs 84,579 crore in 2010, increased to Rs 132,378 crore by 2025. Similarly, grants to states rose steadily from Rs 1,45,557 crore in 2010 to Rs 9,69,391 crore in 2025. This upward trend highlights the growing financial support from the central government to the states over the years.

India’s opposition-controlled states have criticised the Centre for allocating billions of dollars to two of BJP’s allies in this year’s budget. MK Stalin, the chief minister of Tamil Nadu, labelled the budget a “great betrayal,” arguing that it failed to allocate any specific funds to his state despite its significant economic contribution. He accused the BJP of settling “electoral scores” by catering to coalition partners’ demands while neglecting other regions.

Following the recent elections, the BJP lost its parliamentary majority and formed a government with regional parties in Andhra Pradesh and Bihar. In the budget, the finance minister allocated Rs 150 billion through multilateral agencies to Andhra Pradesh for the current financial year, with additional funds planned for the future. Bihar was allocated funds for roads, medical colleges, and railways.

Kerala Chief Minister Pinarayi Vijayan criticised the budget for taking steps to “constrain the state’s finances,” warning that it poses a significant challenge to its autonomy and development.

Finance Minister Nirmala Sitharaman dismissed the Opposition’s claims that the FY25 Budget “ignored” all states except Andhra Pradesh and Bihar as “outrageous.”

ROLE OF 16TH FINANCE COMMISSION

The Opposition’s agitation underscores the need for the newly constituted 16th Finance Commission to address increasing vertical and horizontal inequalities in fund distribution. Formed on December 31, 2023, the Finance Commission is currently discussing its Terms of Reference and will submit recommendations by October 31, 2025, for five years starting April 1, 2026. The Commission must resolve vertical, horizontal, fiscal, demographic, and environmental issues.

CHALLENGES AHEAD

Today, India’s 28 states wield considerable power, employing more people than local and central governments combined. They are constitutionally responsible for or share responsibility for essential services like healthcare, education, law and order, agriculture, and welfare programs.

Given India’s vast political and economic diversity, centrally imposed, one-size-fits-all policies often need to be revised, potentially overlooking critical areas requiring urgent attention and tailored solutions.