Previous Year Question

Horizontal Tax Devolution refers to the distribution of the States’ aggregate share in the divisible tax pool among individual States.

It must be distinguished from Vertical Devolution:

• Vertical Devolution: Distribution of divisible taxes between the Union and all States.

• Horizontal Devolution: Inter-State distribution of the States’ collective share.

The Fifteenth Finance Commission used six criteria for horizontal distribution.

Criteria used by the Fifteenth Finance Commission

Population, Area and Income Distance have already been excluded in the question. Among the listed items, the Commission used:

1. Demographic Performance

2. Forests and Ecology

3. Tax and Fiscal Efforts

The total is therefore: 3

1. Demographic Performance—correct

This criterion rewards States that have performed relatively well in population control and fertility reduction.

It carried a weight of 12.5%. Its design considered demographic performance connected with the 2011 population and the Total Fertility Rate.

It partly addressed concerns that States achieving better population control might otherwise be disadvantaged by using 2011 population figures.

2. Forest and Ecology—correct

Forests provide national ecological services, including:

• Carbon sequestration

• Biodiversity conservation

• Soil and water conservation

• Climate regulation

• Wildlife habitat

States with extensive forests bear an opportunity cost because the land cannot be fully used for commercial purposes. Forest and Ecology therefore received a weight of 10%.

3. Governance Reforms—incorrect

Governance Reforms were not assigned an independent quantified weight in the Horizontal Tax Devolution formula.

Governance performance may be relevant to policy discussions or particular grants, but it was not a separate horizontal-sharing criterion.

4. Stable Government—incorrect

Political stability of a State Government was not used as a tax-devolution criterion. Such a criterion would not constitute an appropriate objective and fiscally neutral basis for constitutional tax distribution.

5. Tax and Fiscal Efforts—correct

This criterion encourages States to make better use of their tax base and improve fiscal capacity.

It carried a weight of 2.5% and recognised performance relating to Own Tax Revenue mobilisation and fiscal effort.

Special importance of Income Distance

Income Distance received the highest weight of 45%. It measures the gap between a State’s Per Capita Income and the Per Capita Income of the benchmark highest-income State.

A lower-income State has a larger Income Distance and generally receives a higher share. The objective is fiscal equalisation.

Final count