A recent overhaul of India's flagship rural employment guarantee programme has reignited a long-simmering financial conflict between the Union government and the states. At the heart of the dispute lies a fundamental question: how should financial resources be shared, and who gets to decide how they are spent?
The Core Grievance: Shrinking State Share
By constitutional mandate, the Union government collects direct taxes, with the Finance Commission determining the share passed on to states. The 15th Finance Commission (2021-2026) recommended that states receive 41% of the Centre's tax collections. However, the actual share of states in total taxes has consistently remained around 33%.
This gap is a primary complaint, especially from more affluent southern states. They contend they are effectively penalised for their economic success, with their higher tax contributions being redistributed to poorer states. The situation has worsened as the Centre's retained tax revenue grows faster than the portion it shares. A key driver of this trend is the Union government's increasing reliance on cesses and surcharges on income and corporate tax.
These levies, constitutionally excluded from the shareable tax pool, accrue entirely to the Centre. Before the Covid-19 pandemic, cesses and surcharges averaged 5.4% of total direct tax collections. This share has now ballooned to 9.9%. States argue this is a strategy to "have its cake and eat it too," allowing the Centre to raise revenue without sharing it.
Conditional Cash and Eroding Autonomy
Beyond the tax share dispute, states protest the strings attached to central funds. Apart from their tax devolution share, which they can spend freely, states receive money for Centrally Sponsored Schemes (CSS). These are programmes designed by the Union government but require states to co-finance them, typically in a 60:40 ratio.
States argue this forces them to divert their limited resources to Union priorities, undermining their fiscal autonomy. For the 2025-26 fiscal year, only about 57.5% of total central transfers to states will be untied funds from tax devolution. The rest comes with conditions attached through CSS or specific-purpose grants.
The Rich State, Poor State Divide and Political Fallout
The dependency on central funds varies dramatically across India. Poorer states like Bihar, Uttar Pradesh, and Madhya Pradesh finance 40-60% of their expenditure through central transfers. In contrast, economically stronger states like Maharashtra (20.8%) and Tamil Nadu (20.2%) are far less reliant.
This fuels the grievance of richer states that they are being shortchanged. However, the economic relationship is symbiotic. Millions of migrant workers from poorer northern states provide cheap labour in the industrial hubs of richer states, which in turn find a vast market for their goods in the north.
The fiscal disparities are stark, with per capita central transfers much higher in poorer states. The issue is set to gain a political dimension post the 2027 census. The subsequent delimitation is expected to increase parliamentary seats for heavily populated, poorer states. Richer states fear a double penalty: fiscal and political. Experts suggest one remedy could be transferring more untied funds to states, granting them greater spending autonomy to balance the impending political shift.
The 16th Finance Commission, chaired by economist Arvind Panagariya, has submitted its recommendations, which are awaited. Its findings will be crucial in addressing these deepening fiscal fault lines between the Centre and the states.
