Reforming India's Fiscal Federalism Post-GST: 16th Finance Commission's Agenda

Key Changes Required for the 16th Finance Commission in the Post-GST Era

Introduction: The implementation of the 101st Constitutional Amendment Act 2016, which introduced the Goods and Services Tax (GST), marked a significant shift in India's fiscal landscape. As the 16th Finance Commission (SFC) is set to be established, it is imperative to reevaluate tax-sharing principles in light of this altered fiscal federalism in India. This article explores the necessary changes and objectives for the 16th Finance Commission.

The Role and Objectives of the Finance Commission: The Finance Commission is a constitutional body responsible for recommending the distribution of tax revenues among the Union and State governments, as well as among the States themselves. It plays a vital role in shaping the fiscal framework for resource allocation through vertical devolution, horizontal distribution, and grant-in-aid.

Post-GST Changes in Fiscal Federalism Landscape: The introduction of the GST replaced the production-based taxation system with a consumption-based one, significantly impacting both vertical and horizontal dynamics of federalism. It shifted the balance of power among states, benefiting consuming states over industrialized ones.

Challenges for Fiscal Federalism Post-GST Changes: Despite these shifts, the federal fiscal transfer system remains rooted in the pre-GST era, leading to a disconnect between the operational tax regime and tax-sharing principles.

What the 16th FC Needs to Do Differently:

1. Re-examine and Redesign Indirect Tax Sharing: The 16th FC should review and redefine the sharing of indirect taxes to account for the pooling of indirect tax sovereignty by both the Union and states.

2. Redefine the Divisible Pool: To align with the new system, the divisible pool must be redefined, incorporating IGST and establishing a normative basis for unsettled IGST to be included.

3. Making Tax Collection More Efficient: Efforts should be made to standardize and reduce the cost of tax collection, given the joint collection by the Union and states.

4. Redesign Horizontal Distribution System: Criteria for distributing the divisible pool among states should be revisited, especially for equalizing grants, to adapt to the shift from production to consumption-based taxation.

5. Review the Compensation Scheme: The viability and necessity of the compensation scheme, along with principles for handling compensation cess collection, should be thoroughly reviewed based on GST's revenue performance.

6. New Institutional Structure of Federal Finance: The relationship between the GST Council and the Finance Commission should be formalized to ensure coordination in determining the size and distribution of the divisible pool.

Conclusion: The 16th Finance Commission must embrace a fresh conceptual, methodological, and operational approach to adapt to the post-GST fiscal landscape. Its terms of reference should guide these necessary changes and ensure a more efficient and equitable fiscal federalism system in India.

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