Centre Plans to Reduce States' Share of Central Taxes from 2026

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Posted by BluraAirport-Admin on 2025-02-28 10:47:24 |

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The Union government is planning to recommend a reduction in the share of central tax revenues allocated to states from 41% to at least 40%. This proposal will be submitted to the Finance Commission of India, which advises on tax distribution and other financial matters between the central and state governments. The commission, led by economist Arvind Panagariya, is expected to present its recommendations by October 31, 2025, for implementation in the 2026-27 fiscal year. While the Finance Commission’s recommendations are not binding, they often influence policy decisions.

The reduction in tax allocation is aimed at addressing the federal government’s increasing expenditure, especially during economic slowdowns. A 1% decrease in states' share could provide the central government with approximately ₹35,000 crore ($4.03 billion) based on current tax projections. Over the years, states’ tax share has risen from 20% in 1980 to 41% today. However, the central government argues that its financial obligations, particularly in infrastructure development, have also increased, necessitating a greater share of revenues.

The move is likely to create tensions between the central and state governments, as states rely heavily on these funds, particularly for social infrastructure such as health and education. Since the introduction of the Goods and Services Tax (GST) in 2017, states have had limited flexibility in generating revenue independently. Additionally, the central government has been increasing its use of cesses and surcharges, which are not shared with states, from 9%-12% of gross tax revenue before the COVID-19 pandemic to over 15% currently.

Another aspect of the proposal involves discouraging states from offering so-called "freebies" such as cash handouts and debt waivers, which are often used for political purposes. The central government may link federal grants to states' adherence to certain financial conditions. While it remains unclear whether states that provide excessive subsidies would be denied grants, such a policy shift could significantly impact state-level spending priorities. Over the past five years, revenue-deficit grants to states have already declined sharply from ₹1.18 trillion ($13.61 billion) in 2021-22 to ₹137 billion ($1.58 billion) in the 2025-26 budget.

This proposed tax-sharing adjustment is expected to fuel debates over fiscal federalism in India, as states may resist any move that reduces their financial autonomy and spending capacity.

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