Earlier this month, the Union Cabinet amended the terms of reference (ToR) of the 15th Finance Commission (FC) to widen their scope. Through the change, the government has requested the FC to look into the possibility of a separate mechanism for the funding of defence and internal security. Critics of the decision have questioned the addition to the FC’s ToR on the ground that it would undermine the federal structure of Indian polity.

What has Centre sought?
The latest addition to the 15th FC’s ToR calls for the FC to examine the possibility of allocation of adequate, secure and non-lapsable funds for defence and internal security of India. In other words, the Centre has requested the FC to examine whether a separate mechanism for funding of defence and internal security ought to be set up, and how such a mechanism could be operationalised.

With capital spending on defence continuing to fall short of requirements, it is difficult to contest the basic premise that spending on defence needs to be bolstered.

However, sequestering funds for defence from the Centre’s gross tax revenues means a reduction in the overall tax pool that is shared with states. This is likely to be protested by the states, several of whom are arguing for an increase in their share in taxes collected to 50 per cent from the current 42 per cent.

Are states being squeezed out of funding?
The added fiscal pressures of the Centre and the requirement of having to share tax revenues with states has left the Centre in a peculiar position.

To shore up its revenues, the Centre has, over the years, begun to rely more on cesses and surcharges. In the recent Union Budget, too, it increased the special additional excise duty and road and infrastructure cess on petrol and diesel by one rupee each.

But the revenue from cesses and surcharges is not part of the divisible tax pool that is shared with the states. It is kept by the Centre. This implies that states receive a lower share of the Centre’s gross tax revenue collections.

For instance, the states’ share in central taxes has been pegged at Rs 8.09 lakh crore in 2019-20. This works out to around 33 per cent of the gross tax revenues. In comparison, post the government accepting the recommendations of the 14th FC, states’ share in central taxes rose to 42 per cent from the 32 per cent earlier.