What is the Divisible Pool of Taxes?

Understanding the Divisible Pool of Taxes

The Divisible Pool of Taxes refers to the portion of the total tax revenue collected by the Union government that is mandatorily shared with the states in India. This mechanism is a cornerstone of fiscal federalism, ensuring financial resources are distributed across different levels of government.

Key Components of the Divisible Pool

The divisible pool primarily includes major tax revenues collected by the Union government. These are significant sources of income that contribute to both central and state exchequers.

• Corporation Tax: Tax levied on the net income or profit of corporate entities.
• Personal Income Tax: Tax levied on the income of individuals.
• Central Goods and Services Tax (GST): A consumption tax levied on the supply of goods and services, shared between the Centre and states.

Role of the Finance Commission

The distribution of the Divisible Pool of Taxes is not arbitrary. It is based on the meticulous recommendations of the Finance Commission, a constitutional body constituted every five years by the President of India.

The Finance Commission plays a crucial role in balancing the financial needs and resources of the Union and the States, ensuring an equitable distribution of funds.

Vertical Devolution Explained

Vertical Devolution refers to the proportion of the Divisible Pool that is allocated between the Union government and the States collectively. It determines how much of the total shared tax revenue goes to the Centre and how much is available for distribution among all states.

For instance, if the Finance Commission recommends 41% of the Divisible Pool for states, this 41% represents the vertical devolution share for all states combined.

Horizontal Devolution Explained

Once the states' collective share (vertical devolution) is determined, Horizontal Devolution dictates how this share is distributed among the individual states. This distribution is based on various criteria recommended by the Finance Commission.

Factors typically considered for horizontal devolution include population, income disparity (often measured by per capita income), area, forest and ecology, demographic performance, and tax efforts made by the states.

Exclusions from the Divisible Pool

It is important to note that not all central government revenues are part of the Divisible Pool. Specifically, Cesses and Surcharges levied by the Union government are explicitly excluded from this sharing mechanism.

These revenues are retained entirely by the Union government, often earmarked for specific purposes or for meeting urgent expenditure needs. This exclusion can sometimes be a point of contention between the Centre and states.