Tamil Nadu’s call for equitable federalism has a sound basis

A case for fiscal fairness, not favour: Tamil Nadu, with its strong economic performance and high human development indicators, is perhaps penalized under the current FC formula that prioritizes equity over efficiency. Transfers are skewed in favour of fiscally weaker states, ignoring governance outcomes, but we need a framework that rewards states for responsible fiscal management and effective service delivery. The state’s demand is rooted in fiscal autonomy and recognition of performance efficiency, its record on which is exemplary.

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Under current FC formulae that favour equity over efficiency, Tamil Nadu receives relatively lower transfers than fiscally weaker states. This is compounded by the Centre’s growing reliance on non-divisible revenues—cesses and surcharges—which rose from 10.4% of gross tax revenue in 2011-12 to over 20% in 2020-21. These funds, not shared with states, shrink the divisible pool, justifying Tamil Nadu’s call for a greater share.

The unchecked growth of non-shared taxes has also undermined state autonomy. Even health and education, domains under the charge of states, face these additional central levies, and despite promises of tax rationalization, they remain bloated and inflexible.

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Common concerns, divergent realities: The frustration of southern states with fiscal devolution reflects deeper structural issues. Their combined share in central tax devolution has declined from 23.3% under the 2nd FC (1957–62) to 15.8% under the 15th (2021–26).

This drop stems largely from the use of 2011 population data (which assigns them a 15% weight) instead of 1971 figures used earlier. The net effect has been to penalize demographically stable states. Having succeeded in population control, these states now face reduced allocations, undermining national development goals. A Brookings India study showed that if the 1971 base had been retained, Tamil Nadu would receive thousands of crores more annually.

Karnataka’s share fell from 4.7% to 3.6%, while Kerala’s has raised similar concerns. The upcoming 2026 delimitation—which may reduce parliamentary seats for these states—adds to their fears of marginalization. This double whammy of fiscal and political disempowerment has led to a collective call for a formula that rewards governance, not just demographic size.

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Equity-versus-efficiency dilemma: Every FC must grapple with balancing equity (supporting weaker states) and efficiency (incentivizing performance). Redistribution of resources is essential, but excessive and unconditional transfers risk fostering complacency. The 13th FC (2010–15) introduced performance grants tied to fiscal discipline and service delivery. But the 15th diluted this, assigning only a 2.5% weight to performance and merging it with other parameters.

Meanwhile, many weaker states still lack the capacity to use funds effectively. Moreover, empirical studies by NIPFP (Rao & Singh, 2021) reveal that many high-transfer states exhibit lower utilization capacity and weaker fiscal accountability. In contrast, states like Tamil Nadu consistently demonstrate effective public expenditure management. A better balanced formula would recognize such outcomes and reward them accordingly.

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Let’s clear the roadblocks: Tamil Nadu’s case is backed by both constitutional principle and data, but the 16th FC faces structural limitations. Unlike its predecessor, its Terms of Reference (ToRs) lack a mandate to consider performance incentives and structural reforms, or address asymmetries caused by cesses and surcharges.

The Centre’s fiscal constraints are another barrier. According to the 2024-25 Union budget, the Centre’s debt-to-GDP ratio stands at 58.9%, far above the Fiscal Responsibility and Budget Management Act target of 40%, and its fiscal deficit is 5.8%. With over ₹10 trillion in annual interest, subsidy and defence expenses, the Centre is hesitant to relinquish fiscal space.

Political asymmetry further complicates matters. Though the FC is constitutionally independent, central influence over its composition and ToRs has sparked concerns, especially after the 15th FC’s contentious directives on defence and demographics.

The rising use of cesses and off-budget borrowings has also reduced transparency. In 2022–23 alone, the Centre collected over ₹5.3 trillion through unshared cesses and surcharges—22% of gross tax revenue. Though FCs can recommend the inclusion of such funds in the divisible pool or their transfer as grants, enforcement requires political will and legislative changes.

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Support cooperative federalism: India’s fiscal future must be rooted in transparency, fairness and performance orientation. Tamil Nadu’s plea is not merely for more funds, but for a rational and just fiscal framework. True cooperative federalism means gradually raising state shares, curbing arbitrary cesses and reinstating performance-linked transfers. The 16th FC has a chance to rebuild trust and rebalance Centre-State relations—for the sake of the Indian Republic.

The author is dean, Vinayaka Mission’s School of Economics and Public Policy.