Centre proposes to cut states' tax share from FY27: Report

The proposal is likely to be cleared by the cabinet of ministers headed by Modi by the end of March and then be sent to the Finance Commission, said a second of the sources.

A 1% swing in the states' share of tax revenues could give Centre about Rs 35,000 crore, based on the expected tax collections for the current year. The final number will vary based on the individual year's tax collections.

An email sent to the Ministry of Finance and the Finance Commission did not get any response.

The share of taxes going to the state governments has jumped from 20% in 1980 to 41% now. But spending requirements for Central government, particularly in years of economic slowdown, have increased, the first source said.

This has led to calls for a lower share of tax revenues going to states, the sources said.

Centre's fiscal deficit is estimated at 4.8% of gross domestic product for 2024-25, while the states have a fiscal deficit of 3.2% of the national GDP.

States have a share of over 60% in total government spending in the economy and typically spend more on social infrastructure like health and education while the federal government's spending is more focused on physical infrastructure.

However, the states have limited discretion in raising revenue since the implementation of the national Goods and Services Tax in July 2017.

Centre, since the COVID-19 pandemic, has also increased the share of cesses and surcharges, which are not shared with the states, to over 15% of the gross tax revenue from 9%-12% earlier.

A shift in resources available to the states could lead to changes in spending priorities.

Centre is also likely to suggest ways to discourage states from giving cash handouts, debt waivers and other so-called freebies by the states for political gains, one of the sources said.

One way to do this would be to link federal grants given to states to make up the shortfall in state tax revenue to meeting certain conditions, the source said, adding that only after meeting those conditions will the states be eligible for such grants.

It was not immediately clear whether federal government would deny grants to states seen as offering freebies.

In the last five years, these revenue-deficit grants have declined from Rs 1.18 lakh crore in 2021/22 to Rs 13,700 crore estimated in the budget for 2025/26.