The ripple effects of the fiscal crisis faced by the Centre are now being felt by state governments. This could potentially strain the already deteriorating relationship between the two. The stress on state finances comes from multiple sources.

First, with the Centre’s tax revenues falling short of expectations, it has significantly lowered tax devolution to states in 2019-20, upsetting the latter’s budget maths.

Second, the Budget speech seems to suggest that shortfall in states’ GST collections will be compensated only to the extent of collections through the compensation cess, and no more. And third, with the government accepting some of the recommendations of the 15th Finance Commission, the share of some southern states in the divisible tax pool has declined. Along with this, other proposals by the Commission, which could impact transfers to state, are also likely to be contested.

In 2019-20, as against a budgeted target of Rs 8.09 lakh crore, the share of states in gross tax revenues fell by Rs 1.53 lakh crore to Rs 6.56 lakh crore. Part of the shortfall, Rs 58,843 crore, is because the Centre had transferred a higher amount to the states in 2018-19. The remaining is because of lower tax collections this year. This shortfall will have a bearing on states’ spending. They can either opt to borrow more to finance their expenditure, in which case their net borrowings will exceed that of the Centre, or they can cut back on spending, further aggravating the slowdown.

Another source of contestation has been the issue of GST compensation. The Budget speech notes that, “hereinafter, transfers to the fund would be limited only to collection by way of GST compensation cess” — hinting at the possibility that states will be compensated only to the extent of collections through the compensation cess. This move, presumably because the Centre’s own finances are under pressure, will amount to the Centre reneging on its promise of protecting states revenue, and could be a justiciable matter.

Another bone of contention has been the use of 2011 population estimates for estimating tax devolution. While the Finance Commission has chosen to minimise criticism by factoring in demographic performance, the share of many, mostly southern states such as Karnataka, Kerala, Telangana, and Andhra Pradesh, has fallen. This will further strain these states’ finances.

Further, while the Commission recommended special grants to ensure that no state receives a lower amount in absolute terms post devolution, the Centre has not accepted it. Moreover, the possibility of setting up a non-lapsable fund or an alternative mechanism for defence and internal security — also on account of the Centre’s limited fiscal space — if carved out from gross tax collections will further reduce the divisible pool for states, and could emerge as yet another stress point in Centre-state relations.

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