RESOURCE SHARING : DEVOLUTION AND DISTRIBUTION
Introduction 5.1 The distribution of the net proceeds of income tax which "are to be", and of the net proceeds of Union excise duties which "may be" divided between the Union and the States under Chapter I of Part XII of the Constitution is the centre-piece of the deliberations of Finance Commissions. Related to this is the issue of determining the respective shares of the States in the distributable proceeds of these two taxes.
5.2 Para 4(ii) of our terms of reference requires us to have regard to "the resources of the Central Government and the demands thereon, in particular, on account of expenditure on civil administration, defence and border security, debt-servicing and other committed expenditure or liabilities".
5.3 In addition, the Central Government has, in a memorandum to us, separately drawn our attention both to the limited scope for adjustment in its expenditure and the likely downward impact on tax revenues in the context of structural reforms in indirect taxation, especially those related to customs duties. The States, on the other hand, have sought larger devolution through upward revisions in their shares in the net shareable proceeds of both income tax and the Union excise duties. In making our recommendations, we have taken into account the overall fiscal scenario of the economy and the submissions of the Central and State Governments.
5.4 We have already discussed the resource position of the State Governments and the Central Government in Chapters III and IV respectively. We now go on to deal with the specific issues relating to the devolution of income tax and Union excise duties and make our recommendations pertaining to the aggregate share of all States in the net proceeds of these taxes, and their individual shares in respect of both the taxes.
Income tax 5.5 Under the provisions of article 280(3)(a), read with article 270 of the Constitution, our task with respect to income tax is to make recommendations in regard to three matters, viz.
a) the percentage of the "net distributable proceeds" which shall represent the proceeds attributable to the Union Territories ;
b) the percentage of the divisible pool of the "net proceeds" of income tax to be assigned to the States; and
c) the share of each State in the divisible pool.
5.6 Under article 270(3) of the Constitution, the share of the net proceeds of income tax "attributable to the Union Territories" has to be prescribed. Previous Finance Commissions had adopted the practice of treating all Union Territories together as a group, and determining their joint share by applying the same principles as for the other States. As would be evident in the ensuing discussion, we have used some allocative criteria for the States for which adequate corresponding information for the Union Territories is not available. We have, therefore, decided to determine their share on the basis of population. We recommend that the share attributable to the Union Territories in the net distributable proceeds of income tax for each of the financial years during 1995-2000 should be 0.927 per cent.
5.7 The present share of the States in the net proceeds of income tax is eighty five percent. It would be useful to review the path that this ratio has traversed through the recommendations of earlier Commissions. The States share out of the net proceeds of income tax was fixed at 55 per cent by the First Commission. The succeeding three Commissions enlarged the share progressively to 60 per cent, 66 2/3 per cent and 75 per cent. While recommending the increase in the States' share, the Third and Fourth Commissions took due note of the representation of the States about the need for making good in some measure the loss sustained by them on account of the non-inclusion of corporation tax in the divisible pool consequent upon the reclassification brought about in the Income Tax Act in 1959. The Fifth Commission did not recommend any further increase in the States share, on the ground, among others, that the divisible pool of income tax would for the first time also include advance tax collections. Arrears pertaining to the advance tax collections were distributed among the States in three instalments during the period covered by the recommendations of that Commission.
5.8 The Sixth Commission raised the States share from 75 to 80 per cent taking into consideration various factors including the fact that the arrears referred to above were no longer available. The share of the States was further increased to 85 per cent by the Seventh Commission keeping in view the States grievance in regard to the levy of surcharge by the Centre as a normal tax revenue measure. The Eighth and the Ninth Commissions let it remain at 85 per cent.
5.9 Notwithstanding its present high level, a number of States have sought an increase in the States' share in income tax While Bihar has favoured a figure of hundred per cent, Arunachal Pradesh, Goa, Madhya Pradesh, Punjab and Uttar Pradesh have indicated a figure of 95 per cent. Gujarat, Nagaland, Orissa, Tripura and West Bengal have called for an upward revision in this share to 90 percent. Rajasthan and Tamil Nadu stressed the need for an increase in the share. Andhra Pradesh, Assam, Himachal Pradesh and Kerala have not suggested any change in the existing share of 85 per cent. Mizoram has proposed a reduced share of 65 percent in favour of a larger flow of resources through grants-in-aid.
5.10 Haryana and Karnataka have suggested that the proceeds of corporation tax and income tax be pooled and the share of the States may be fixed at 50 per cent. Alternatively. Karnataka would like that 85 per cent and 1 5 per cent shares respectively out of the net yields from income tax and corporation tax be distributed among the States. Maharashtra is in favour of reducing the States' share to 75 per cent provided 20 per cent of the proceeds of the corporation tax are also simultaneously shared. However, pending a Constitutional amendment to this effect, the State would not want any change in the existing share of 85 per cent. Haryana, Punjab and West Bengal have even suggested that till the Constitution is amended, a compensatory grant equal to a specified percentage of the net proceeds may be
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recommended in lieu of sharing the corporation tax with the States.
5.11 The main grounds on which the States have pleaded for an enhancement in the share of income tax proceeds may be summarised as below:
i) As compared to income tax, corporation tax has turned out to be more buoyant but its proceeds, which were shareable prior to the Income Tax Act amendment in 1959, have been excluded from the divisible pool.
ii) States were losing revenue due to the surcharge on income tax being continued by the Centre as a normal source of revenue.
iii) Various kinds of reliefs and concessions being provided in the Central budget almost every year and periodic increases in the basic exemption limit for income tax have led to a shrinkage of the divisible pool.
iv) The expenditure responsibilities of the States, particularly for infrastructure, have grown in the wake of economic liberalisation.
5.12 The States have been pleading for-inclusion of the proceeds from corporation tax in the divisible pool for a long time now. We understand their desire to share the proceeds of corporation tax. This issue deserves to be seen in the wider context of diversifying and broadening the base of tax devolution. We have given our views in this regard in the alternative scheme of devolution suggested in Chapter XIII.
5.13 An umber of States have raised the issue regarding the reintroduction of surcharge on income tax in 1987-88. The States have pointed out that instead of the measure being used for meeting any emergent requirements of a specific nature, the surcharge was being continued by the Centre as a normal source of revenue. In the process, the States were losing considerable revenue which would have been available to them had it been integrated into the income tax rates. We note that the Centre has completely withdrawn the surcharge on income tax from the financial year 1994-95. We, nevertheless, would like to emphasise that the surcharge on income tax should not be levied except to meet emergent requirements for limited periods.
5.14 States have been critical of the allocation of the cost of collection' as between income tax and corporation tax. This cost is deducted from the proceeds of income tax while working out the share of States. They regarded as unfair the ratio of 7:1 which was fixed-on the basis of the findings of an expert committee set up in 1985 at the suggestion of the Eighth Commission. Some States have suggested allocation of the collection charges in proportion to the yields from income tax and corporation tax. A few States desire that due weightage be given to the workload involved under the respective taxes. The Ninth Commission, before which the States had made similar suggestions, had felt that there was need to re-examine the entire matter taking into account factors such as the introduction of simplified procedures of assessment and the nature and complexity of the cases involved under the respective taxes.
5.15 In pursuance of the observations made by the Ninth Commission in its first Report, an Expert Committee headed by Shri M.M.B. Annavi, Additional Deputy Comptroller and Auditor General of India was constituted by the Government of India on the 8th of June, 1989 to examine the apportionment of the cost of collection between income tax and corporation tax. The committee has observed in its report that:
a) the number of officers deployed in the collection of corporation tax and income tax is in the ratio of 255:1926 or 1:7.5 ;
b) the ratio between the number of officers engaged in assessment of corporation tax and income tax in mixed circles, after segregation, works out to 1:6.52; and,
c) there has been no significant reduction in the workload involved in individual assessments with the introduction of a summary assessment scheme with effect from 1st April, 1989 because every individual return is required to be physically checked to detect arithmetical errors, and examine the admissibility of deductions.
5.16 The Committee after analysing various parameters which could have a bearing on the cost of collection concluded that it would be reasonable to apportion the cost of collection of corporation tax and income tax in the ratio of 1:6.5. This ratio has been worked out after a detailed study by experts which included representatives of the State governments. It is being used currently. This may be considered acceptable.
5.17 The States have further contended that the receipts from `penalties' and `interest receipts', which form part of the "miscellaneous receipts", should be included in the divisible pool of income tax. The Eighth Commission had recommended the inclusion of these receipts in the divisible pool on the ground that since the power to levy penalties and recover interest under the Income Tax Act emanates from the power to levy income tax itself, these two classes of receipts must fall within the concept of `income-tax' as that term is used in article 270 of the Constitution. The Ninth Commission examined the matter de novo, and keeping in view the pronouncements of the Supreme Court on the subject and other relevant factors, recommended that receipts on account of `penalties' and `interest receipts' should form part of the divisible pool of income tax.
5.18 We have been informed by the Ministry of Finance that the matter is under their active consideration. We are of the opinion that the receipts on account of interest recoveries and penalties form part of the divisible pool and should be shared with the States. We, therefore, recommend that this should be done with effect from 1st April, 1995.
5.19 Karnataka, Rajasthan and Tamil Nadu have contended that the receipts from pre-emptive purchases of immovable properties represent accretions to capital gains and should, therefore, form part of the income tax pool for purposes of sharing. On a representation made by the Tamil Nadu Government, this matter was examined by the Ninth Commission in its first Report. The Commission felt that, as this was a matter of accounting procedure, it would be appropriate if the matter was settled in consultation with the Comptroller and Auditor General of India. Now more States have raised this issue with us. They have pointed out that the amount involved may be significant and the device of using pre-emptive purchases under the Income tax Act is now widely spread in many metropolitan towns. They argue that the proceeds arising out of the scheme are in the nature of capital gains and should be shared with the States. The Ministry of Finance has expressed the view that these receipts do not form part of the shareable proceeds of income tax. We are of the same opinion.
5.20 We now return to the key issue of determining the share of the States in the net proceeds of income tax. Having considered this matter at length, we have come to the conclusion that our recommendation in the matter should be guided by two considerations, viz.
i) that the authority that levies and administers the tax should have a significant and tangible interest in its yield, and
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ii) that any change in the share on this account should not materially affect the level of overall devolution to the States.
In other words, any downward revision in the share of States in the net proceeds of income tax should be mirrored in a revenue equivalent increase in their share in the net proceeds of Union excise duties.
5.21 Accordingly, we recommend that the share of States in the net proceeds of income tax be fixed at 77.5 per cent. We later recommend a suitable increase in the share of the States in Union excise duties. These changes reflect our concern that the Centre retains adequate interest in income tax.
Union Excise Duties 5.22 Entry 84 of list I (Union List) of the Seventh Schedule read with article 272 of the Constitution vests in Parliament the power to levy Union excise duties. The article also provides for the sharing of the net proceeds of these duties with the States, if Parliament by law so provides.
5.23 The sharing of Union excise duties started with the First Commission itself, although the beginning was modest. It was restricted to 40 per cent of just three commodities, viz. tobacco, matches and vegetable products.
5.24 Since then, the sharing of the net proceeds of Union excise duties has become a regular feature, with successive Finance Commissions devolving larger amounts to the States, through either upward revisions of the coverage of the shareable items, or by increasing the magnitude of the States' share. The Second Commission extended the list of shareable commodities to eight but reduced the States' share to 25 per cent. The Third Commission reduced the States' share to 20 per cent but enlarged the list of shareable items to 35, the yield from each of which was Rs.50 lakh or more per year. Since the Fourth Commission, the coverage of items for States' share has been near universal, but the States' share was limited to 20 per cent. The Seventh Commission doubled the States' share to 40 per cent on the ground that if the States had sufficient resources with them their dependence on the Centre would be reduced. The Eighth Commission raised this share to 45 per cent, but the increment of 5 per cent was used for meeting the assessed post-devolution deficits of the States. The Ninth Commission let the overall share remain at 45 percent, but used 5 percent and 7.425 percent from it for deficit-based devolution, in its First and Second Reports, respectively. In effect, therefore, the portion of the net proceeds of Union excise duties from which all States receive a share was 40 per cent for the Eighth Commission. It remained so in the one year (1989-90) report of the Ninth Commission, but it was reduced to 37.575 per cent in its second report pertaining to the period 1990- 95.
5.25 States have generally asked for an upward revision in their share in the net proceeds of Union excise duties from the present 45 per cent to 55 per cent and even 60 per cent. They have also pleaded for an enlargement of the divisible pool by including cesses levied under specific Acts, and a portion (20 per cent) of the yield from administered prices which are periodically increased by the Government. Some State Governments argue that instead of raising the administered prices, the Government should raise the excise duty tariff on the concerned product. This will automatically entitle the States to a share in the proceeds.
5.26 It may be noted that, in the context of the greater market orientation of the economy, the scope for the Central Government to raise administered prices would be progressively constrained except in cases where it might have a monopoly. We would suggest that even in these cases, decisions to raise administered prices should aim at minimising budgetary support and increasing operational efficiency of the concerned public enterprises.
5.27 As regards the inclusion of revenues from the cesses in the divisible pool, it may be mentioned that a cess is levied on a specified commodity and is governed by a special Act of Parliament with the stipulation that it should be utilised for the development of the specific industry, the products of which bear the cess. The proceeds of such cesses cannot, therefore, be shared with the States.
5.28 Having regard to the views of the Central and the State Governments in the matter, and having recommended a decrease in the States' share of the net proceeds of income tax, we further recommend that the share of States in the net proceeds of Union excise duties be raised to 47.5 per cent.
Distribution of Divisible Amounts 5.29 The criteria for determining the inter se shares of States in income tax and Union excise duties have tended to converge since the recommendations of the Seventh Commission. However, 10 percent of the distributable amount of income tax was allocated amongst the States on the basis of contribution and a portion of Union excise duties set aside for distribution according to assessed deficits. The convergence of the criteria determining the shares of States in the remaining portion of these two taxes is a move in the right direction. We now consider the determination of the inter se shares of States in income tax and excise duties.
5.30 For the distribution of the net proceeds of income tax among the States, successive Finance Commissions, till the Seventh Commission, gave weightage to population as a major factor and `contribution' as a minor factor. The Eighth and the Ninth Commissions gave a weight of 10 per cent to the factor of contribution in the distribution of the net proceeds of income tax, but reduced the weight of population substantially.
5.31 In their memoranda submitted to us, while nine States have favoured providing a weightage ranging from 10 per cent to 45 per cent to the `contribution' factor, fourteen States are against including it at all in the distribution criteria. As for the `population' factor, while eighteen States have recommended its retention, there is wide divergence in the views regarding the weightage to be given to it. Haryana and Punjab want to increase the weightage to 100 and 80 percent, respectively. Maharashtra has suggested 55 per cent, while Karnataka, Kerala, Nagaland and Uttar Pradesh want it kept at 50 per cent. The other States have proposed weights ranging from 20 per cent to 40 per cent.