PROPOSING A 2-FACTOR FORMULA FOR SHARING

THE 16th Finance Commission so far visited 16 states; visits to 12 more will be completed in the next few months.

- R SRINIVASAN

The commission has covered most of the Northeastern and Himalayan states as well as smaller states.

The information from news reports on these visits show that all states have raised two issues. One, increasing the combined share of states in the divisible pool of Union tax revenue to 50 percent and including cess and surcharges in the divisible pool. Two, change the horizontal distribution formula to protect each state's interests.

Gujarat and Southern states have argued to give efficiency a greater weight, and other smaller states have argued based on their specific fiscal problems. This is the opportune moment for states to argue for a transformative change in the horizontal distribution formula.

Basics of a horizontal distribution formula: The formula is to address the budget deficits or fiscal gaps in states' budgets. The differences in fiscal gaps is because states differ in terms of population, revenue capacity, area, other specific problems and efficiency factors. Finance commissions recommend a distribution formula assigning different weights to these indicators and the indicators are also defined variously by them.

Because finance commissions change these complex formulas, the states cannot easily predict how their fiscal behaviour will be assessed by future commissions. But the overall analysis suggests that ultimately a state's share in tax revenue increases with its population and declines with its income, as the Finance Commission prefers equity to efficiency.