States may lose out on their shares in taxes as the Centre is likely to seek a bigger slice of tax devolution to the 16th Finance Commission, scheduled for May 2025, because of elevated market borrowings and repayments.
“As part of the submission, the Union government will seek to increase its share, which means to decrease the share of states in the tax devolution. This recommendation would be supported by expenditure carried out in the past by the Centre and the tax receipts it receives,” an official told Moneycontrol, adding that while borrowings and interest payments are on the rise, expenditure is not being utilised productively in the economy.
There have been attempts to push spending through infrastructure development, capital expenditure remained muted as the government has spent up 42 percent of the budgeted Rs 11.11 lakh crore for FY25 so far, compared with 54.7 percent spent during the April-October period last fiscal.
Loans, including those disbursed to states for infrastructure facelift, has declined close to 13 percent up to October as freebies gained priority over capex because of the elections.
The Centre’s demand for a larger chunk in the devolution pie could very well be at crosshairs with states, with some seeking a hike in their stakes in the divisible pool of taxes to as much as 50 percent, a second official said.
As recently as earlier this year, Karnataka and some more southern states claimed that they were being deprived of their legitimate share from central taxes, while the Centre cited the Finance Commission norms to defend the current levels of devolution.
As per the recommendation of the 15th Finance Commission, 41 percent of the divisible tax pool of the Centre is transferred to states in 14 instalments annually, covering the five-year period of 2021-22 to 2025-26.
“The Centre will submit a memorandum recommending the share of devolution between the Centre and the states to the 16th Finance Commission. Some states are asking for a higher share. While the formula deciding how much share goes to which state may stay the same. Some states have been asking for a 50 percent share, but that is an arbitrary demand. Centrally sponsored schemes are already taking care of the spending on many of the sectors on the state list,” the second official added.
The 16th Finance Commission headed by Arvind Panagariya, former vice-chairman of the Centre's topmost think-tank Niti Aayog, will make its report available by October 31, 2025, covering a period of five years starting April 1, 2026.
The Commission’s terms of reference will include the distribution of the net proceeds of taxes between the Centre and the states and the allocation between the states of the respective shares of such proceeds, the principles, grants-in-aid and the revenues of the states and measures needed to supplement the resources of the panchayats.
The final decision on the percentage of devolution to the Centre and the states lies with the Finance Commission.
More funds on the cards?
The Centre’s push for a higher share in the divisible pool of taxes comes at a time when the government is looking to lower its borrowings from the bond market and curtail its fiscal deficit to below 4.5 percent of the GDP by 2025-26.
It also has to clear repayment of debt issued during the pandemic amounting over Rs 4 lakh crore next fiscal, which is expected to jack up its gross borrowings in FY26. The gross market borrowings for 2024-25 has been pegged at Rs 14.01 lakh crore, drastically lower than Rs 15.43 lakh crore borrowed in the previous fiscal.
However, the share devolved to states may already be lower than the recommended levels.
India Ratings and Research in a February 6 note had pointed out that tax devolution given to states has been significantly lagging compared to the recommended levels of the 15th Finance Commission.
For FY25, the government budgeted to share 35.5 percent of the divisible tax pool (gross tax revenues net of cess and surcharges, excluding GST compensation cess, and taxes of Union Territories) with states, lower than the suggested 41 percent. The states’ share in central taxes has been trending downwards, averaging 35.4 percent of the divisible pool during FY21-FY25, down from 39.8 percent during FY16-FY20, it said.
Latest available data shows that the government has transferred Rs 7.23 lakh crore to states as their share in taxes from April to October this year, which is Rs 1.94 lakh crore higher than the previous year.
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