Budget 2020: States' share in central tax pool seen at 50-year low

As the economic slowdown takes a toll on the central government's tax revenues, state governments are being asked to share a bigger burden of the fiscal slippages. The share of states in the central tax pool is set to decline by 13.8 per cent year-on-year (YoY) during fiscal year 2019-20 (FY20). This will be biggest fall in states' share in central taxes in 50 years, according to the data from the Reserve Bank of India.


The states’ revenue from the central tax pool was up 25.8 per cent YoY in FY19, while it was down 0.4 per cent YoY in FY18. The current fiscal year will be only the third occasion in the past 50 years when states' share in taxes will decline on a YoY basis. The share of states in the divisible tax pool had declined for the first time in FY1998-99 followed by a decline in FY18.


The tax receipt data for central and state governments in only available since FY1970-71.


Lower tax transfer to states spared the central government the blushes as gross tax is estimated to grow by just 4 per cent YoY in FY20, against 16.5 per cent YoY in the central government's total expenditure during the year. As a result, the central government's expenditure is down by only around Rs 88,000 in Revised Estimates for FY20 against a Rs 3-trillion shortfall in gross tax collections.


Foreign brokerage Credit Suisse (CS) flagged it off as a risk. "States appear to be bearing a large part of the tax slippages. Revenue transfer to states drops by nearly 50 per cent of the cut in gross tax receipt assumptions," write CS analysts, led by Neelkanth Mishra and Prateek Singh.


The central government’s gross tax collections are down by nearly Rs 3 trillion in Revised Estimates (RE) for FY20 over the Budget Estimates (BE) presented in the last year’s Budget. Of this, states absorbed a tax blow of Rs 1.543 trillion. According to RE, states will now receive Rs 6.56 trillion from the central tax pool in FY20 against BE of Rs 8.1 trillion.

Interestingly, the decline in states’ share in FY20 is similar to the expected decline in corporation tax collection. Corporation tax collections are likely to be lower by Rs 1.55 trillion in RE for FY20 over the BE for the current fiscal year.


As a result, the share in central taxes will now account for only 29.6 per cent of states’ total tax revenues, lowest since FY03, when it had hit a low of 29.3 per cent.


Economists say that decline in states share could adversely affect states’ finances besides hitting overall capital expenditure in the economy. “States’ spending on capital expenditure is far larger than the central government capex. Post a cut in their revenue share, states' will either have to adjust their expenditure to fit lower revenues or they will have to borrow more that will worsen their fiscal math," says Devendra Pant, head economist India Ratings & Research.


A large part of states' capital expenditure is towards irrigation, roads, education, healthcare, water supply and sanitation. The worry is the new fiscal math may force many states to either abandon or defer new projects on these areas adversely affecting the overall capex in the economy.


Additional borrowing by state government is also likely to push up bond yields and interest rates. This in turn will also increase borrowings costs for corporates and individuals.


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