2 minEconomic Concept
Economic Concept

Tax Devolution

What is Tax Devolution?

Tax devolution is the process by which a portion of the net proceeds of taxes collected by the Union government is transferred to the state governments. It is a key mechanism for vertical fiscal transfers, aiming to bridge the gap between the revenue-raising capacity and expenditure responsibilities of the Centre and States.

Historical Background

The concept of tax devolution has been integral to India's fiscal federal structure since independence. The Constitution provides for the sharing of certain central taxes with states. The percentage of the divisible pool and the criteria for its distribution among states have been continuously reviewed and recommended by successive Finance Commissions, adapting to changing economic realities and fiscal needs.

Key Points

10 points
  • 1.

    Constitutional Mandate: Article 270 of the Indian Constitution mandates the sharing of certain taxes levied and collected by the Union with the States.

  • 2.

    Divisible Pool: The 'divisible pool' for tax devolution comprises all Union taxes and duties, except for cesses and surcharges, which are typically retained by the Centre.

  • 3.

    Vertical Devolution: The Finance Commission recommends the percentage share of the divisible pool that should go to the states as a whole (e.g., 41% by 15th FC).

  • 4.

    Horizontal Devolution: The Finance Commission also recommends the criteria for distributing the states' share among individual states. These criteria aim to address horizontal imbalances.

  • 5.

    Key Criteria for Horizontal Devolution (15th FC): Income Distance (45%), Population (15% for 2011 census), Area (15%), Forest & Ecology (10%), Demographic Performance (12.5%), Tax & Fiscal Effort (2.5%).

  • 6.

    Purpose: To ensure that states have adequate resources to fulfill their constitutional responsibilities, promote balanced regional development, and reduce both vertical and horizontal fiscal imbalances.

  • 7.

    Impact on States: States receive a significant portion of their revenue through tax devolution, which is untied funds, giving them flexibility in spending.

  • 8.

    Role of Finance Commission: The Finance Commission is the sole constitutional body responsible for recommending the principles and quantum of tax devolution.

  • 9.

    Difference from Grants-in-Aid: Unlike grants-in-aid (Article 275), which can be conditional or specific, tax devolution provides untied funds to states.

  • 10.

    GST Impact: The introduction of GST changed the nature of indirect tax sharing, but the principle of devolution for central taxes (like corporate income tax, personal income tax) remains crucial.

Visual Insights

Understanding Tax Devolution

This mind map outlines the key aspects of tax devolution in India, including its purpose, criteria, and constitutional basis.

Tax Devolution

  • ●Purpose
  • ●Criteria
  • ●Constitutional Basis
  • ●Divisible Pool

Recent Developments

4 developments
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The 15th Finance Commission recommended a 41% share of the divisible pool for states for the period 2020-2025, a slight reduction from the 14th FC's 42% due to the conversion of Jammu & Kashmir into a Union Territory.

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Increased concerns from states regarding the growing share of cesses and surcharges, which are not part of the divisible pool, thereby reducing the funds available for devolution.

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Debates on the weightage given to various criteria for horizontal devolution, particularly population and income distance, affecting 'net contributor' states.

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Impact of economic slowdown and COVID-19 on the overall tax buoyancy and, consequently, the quantum of funds available for devolution.

This Concept in News

1 topics

Finance Commission Report: Tax share changes for poll-bound states

9 Feb 2026

This news highlights the practical application of tax devolution principles. The Finance Commission's adjustments to state tax shares demonstrate how the criteria for devolution are applied in practice, considering factors like economic performance, population changes, and specific state needs. The news also reveals the potential challenges and controversies associated with tax devolution, as states may disagree with the Commission's recommendations and their impact on their budgets. Understanding tax devolution is crucial for analyzing this news because it provides the context for understanding why these changes are happening and what their potential consequences are. It also helps in evaluating the fairness and effectiveness of the current system of fiscal federalism. The news underscores the importance of the Finance Commission as a key institution in maintaining a balanced and equitable distribution of resources among states, but also the political sensitivities involved in this process. Without understanding the underlying principles of tax devolution, it's impossible to fully grasp the significance of these changes and their implications for state economies and development initiatives.

Source Topic

Finance Commission Report: Tax share changes for poll-bound states

Polity & Governance

UPSC Relevance

Crucial for UPSC GS Paper 2 (Polity and Governance) and GS Paper 3 (Economic Development). Understanding tax devolution is essential for analyzing Centre-State financial relations, state budgets, and the redistributive aspects of India's federal system.

Understanding Tax Devolution

This mind map outlines the key aspects of tax devolution in India, including its purpose, criteria, and constitutional basis.

Tax Devolution

Reduce Vertical Imbalance

Reduce Horizontal Imbalance

Population

Income Distance

Article 280

Finance Commission

Includes most Union Taxes

Excludes Cesses

Connections
Tax Devolution→Purpose
Tax Devolution→Criteria
Tax Devolution→Constitutional Basis
Tax Devolution→Divisible Pool

This Concept in News

1 news topics

1

Finance Commission Report: Tax share changes for poll-bound states

9 February 2026

This news highlights the practical application of tax devolution principles. The Finance Commission's adjustments to state tax shares demonstrate how the criteria for devolution are applied in practice, considering factors like economic performance, population changes, and specific state needs. The news also reveals the potential challenges and controversies associated with tax devolution, as states may disagree with the Commission's recommendations and their impact on their budgets. Understanding tax devolution is crucial for analyzing this news because it provides the context for understanding why these changes are happening and what their potential consequences are. It also helps in evaluating the fairness and effectiveness of the current system of fiscal federalism. The news underscores the importance of the Finance Commission as a key institution in maintaining a balanced and equitable distribution of resources among states, but also the political sensitivities involved in this process. Without understanding the underlying principles of tax devolution, it's impossible to fully grasp the significance of these changes and their implications for state economies and development initiatives.