(wl-3031)-Horizontal Distribution of Federal Transfers: Unpacking the Population Criterion

Horizontal fiscal imbalance across the states in India increasingly persists due to differences in resource endowments, population composition, geographical and climatic conditions, tax effort, level of development and policy paradox. The Finance Commission (FC) consistently uses population criterion [population size using criterion (PSC)] with significant weight (explicit plus implicit in equity and efficiency) to distribute revenue transfers (central shared taxes) among states over successive Commissions in solving the fiscal imbalance. Investigating the nature of the PSC, this study finds that PSC provides equal per capita share to each state irrespective of differences in population composition across states assigning equal weightage to all active and inactive populations. States with larger inactive population fail to generate sufficient fiscal capacity to meet their larger expenditure responsibilities. Whereas states with larger share of active population are able to gather adequate fiscal capacity to meet the fiscal needs of inactive population. The assignment of equal weightage to both categories of state increases horizontal fiscal imbalance. Population composition criterion that provides significant weight to inactive population with minor weight to active population, ensures due share to each state. It may be helpful to reduce the horizontal fiscal imbalance which is a matter of consideration for the Sixteenth FC while horizontally sharing the central shared taxes.