The fight for fiscal autonomy

The erosion of fiscal autonomy does not bode well for our federal structure and will thwart the growth of developed States

August 09, 2022 12:15 am | Updated 12:32 pm IST

A two-wheeler gets his vehicle refuelled at a petrol pump in Erode in Tamil Nadu.

A two-wheeler gets his vehicle refuelled at a petrol pump in Erode in Tamil Nadu. | Photo Credit: M. GOVARTHAN

In a recent debate between Union Finance Minister Nirmala Sitharaman and Opposition MPs on price rise, Ms. Sitharaman said the States should do more, ignoring the fact that the reduced fiscal autonomy of the States gives them little leeway to do much. Similarly, the increasing reliance of the Union government on indirect taxes such as the GST has directly contributed to price rise and inequality. But despite reduced fiscal autonomy, States such as Tamil Nadu and Kerala have contained price rise and inflation through targeted interventions.

Growing inequality

Adam Smith had argued that taxation per se is not bad, but should follow the principles of fairness. Fairness, in taxation, should be compatible with taxpayers’ conditions, including their ability to pay in line with their personal and family needs. However, the Union government’s increasing dependence on indirect taxes has removed any ‘fairness’ in taxation. The share of indirect taxes of the gross tax revenue in FY2019 increased by up to 50% compared to 43% in FY2011. Compare this with the OECD countries, where indirect taxes on average do not contribute to more than 33% of their tax revenue. Indirect taxes are regressive because they tax both the rich and the poor equally.

The poor get taxed a higher proportion of their income compared to the rich. For example, Indians on average spend 22% of their income on fuel, the highest in the world. Also, Union tax on diesel has increased by 800% since 2014, which, after recent reductions, stands at 300%. While indirect taxes have increased, direct taxes such as corporate tax have been reduced from 35% to 22%, leading to a loss of about ₹2 lakh crore to the exchequer. This over-reliance on indirect taxes not only hinders growth by thwarting demand, but can also lead to high inflation and high inequality, which again inhibit growth.

The reason for high inflation in India lies in the extremely high CPI index for food (over 15% in the recent past). Instead of making efforts to lower food prices, the Union government, via GST, increased taxation on basic food items such as rice and milk.

It is not a mere coincidence that India’s increasing reliance on indirect taxes has coincided with rising inequality and lower growth. Over recent years, wealth has remained concentrated in the top echelons of society. According to the World Inequality Report 2022 report, the top 1% of India’s richest held 22% of the total national income as of 2021 and the top 10% owned 57% of the income. The report also showed that India is one of the most unequal countries in the world. Furthermore, the World Poverty Clock identifies India as home to the second highest number of extremely poor people.

Tamil Nadu’s performance

Inflation, and predominantly rural inflation, has touched double digits in some States. Tamil Nadu and Kerala have been able to buck the trend of high inequality and inflation. To understand the low inflation rates in Tamil Nadu, one has to look at how inflation is calculated. Inflation is based on weighted average of components such as transport and food, which are given a weightage ranging from 6% to 10% basis points. Due to Tamil Nadu’s efficient Public Distribution System and welfare schemes such as free bus travel for women, inflation or price rise has been negated to a greater extent. Apart from low inflation, Tamil Nadu and Kerala also occupy a leading position on several socio-economic indicators such as graduate enrolment ratio and female participation in the labour force. This was possible because these States had a head start in launching socio-economic programmes. It is the state that mostly implements schemes and provides basic necessities to the citizens. It is therefore the state which can improve the lives of citizens.

But States require fiscal autonomy to implement these programmes. There has been a substantial erosion in Tamil Nadu’s fiscal autonomy in the last few years. While a developed State such as Tamil Nadu gets only 30 paisa in return for every rupee it contributes to the Union, States such as Uttar Pradesh and Bihar get ₹2 to ₹3 for every rupee contributed. Arbitrary increases on cess and surcharge, which are non-divisible with States, have further reduced the individual States’ fiscal resources. The share of cesses and surcharges in the gross tax revenue of the Union government has nearly doubled between 2011-12 and 2020-21. Such continuous erosion of fiscal autonomy does not bode well for India’s federal structure and will only thwart the growth of developed States. The Union government should urgently initiate a course correction on its taxation policy and fiscal autonomy.

Salem Dharanidharan is the spokesperson of the DMK and executive coordinator of the Dravidian Professional Forum

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