Tax mop-up doubles in the first quarter but transfers to states shrink

Devolution accounts for just 22% of gross tax revenue in the first quarter

Though the Centre’s gross tax revenues nearly doubled in the first quarter of financial year 2021-22 (Q1FY22) compared to last year, transfers to states in the form of devolution declined by 12.3 per cent, which experts say will impact states’ spending, especially as they battle economic uncertainty due to the pandemic. 

The Centre’s gross tax revenue in Q1 doubled to Rs 5.31 trillion, compared with Rs 2.69 trillion in the corresponding period last year. It devolved Rs 1.17 trillion to the states, compared with Rs 1.37 trillion last year, when the devolution accounted for about half of the gross collected. This year the devolution is just 22 per cent of the gross tax mop-up.

The devolution is typically given as a fixed percentage of the Budget Estimate every month. It was at 6 per cent of BE in Q1 2020-21 and is the same in Q1 of the current fiscal.  But economists argue that the Centre must change its stance as revenues were higher than expected.

Aditi Nayar, chief economist at ICRA Ratings, said maintaining a monthly devolution at Rs 39,175 crore over the coming months may be cash flow inefficient for states. “Unless the monthly amount of devolution is imminently increased from Rs 39,175 crore, the balance left to be devolved in Q4FY22 would be substantial, which would be inefficient from a cash flow perspective for the states,” she added. 

Moreover, retention of monthly tax devolution at existing levels, would back-end the release of a third of the taxes budgeted for FY22 to March. Hence, the monthly amount could be stepped up in FY22, unlike in FY21, said Nayar.

If the Centre sticks to the existing level of devolution, about Rs 2.4 trillion, 36 per cent of the FY22 BE ('6.7 trillion), will be left for devolution in March. 

Madan Sabnavis, chief economist at CARE Ratings, said this will result in pressure towards the end of the year and may force the government to borrow more. “The consequence is the government may have to borrow more for this. The crux will be disinvestment taking off to ensure that capex is not cut,” said Sabnavis. He added that this will be a problem for states as they may cut back on capex if funds don’t come in time. They are borrowing less, he said.

States are entitled to 41 per cent of the Centre’s divisible tax pool in the form of devolution. Cesses, which form a large part of the excise mop-up, are out of the divisible pool. Direct-tax-to-GDP ratio in Q1FY22 increased to 5.14 per cent, as against 3.29 per cent over the last two years, thanks to growth in corporation and personal income tax collection.

Devendra Kumar Pant, chief economist at India Ratings, said states’ share in central taxes is based on the Budget Estimate of gross tax revenue and its breakup between sharable and non-sharable (cess) taxes. “Until the Union government provides a Revised Estimate of gross tax revenue, transfer to states will be on the basis of Budget Estimate… Having said that, the Union government on the basis of its assessment of higher gross tax revenue collection can decide to transfer a higher amount,” he said.

The central tax devolution makes up for about 25 per cent of states’ combined revenue receipts, though its share varies across states.  Nayar added that monthly devolution used to be fairly stable in earlier years, providing predictability to the cash flows to state governments.

Before FY19, the Centre used to devolve one-fourteenth of the budgeted CTD in April-February of each fiscal year and made adjustments based on the RE in March. This was essentially because the government usually gets higher tax collections in March. The monthly pattern changed after FY20, with the Covid-19 pandemic impacting the Centre’s tax revenues.

If the government chooses to modify the devolution for the June-February period to one-fourteenth of FY22BE, it would mean a tax devolution of Rs 47,500 crore a month during this period, according to ICRA Ratings.

This might force the Centre to borrow more later in the year. It is estimated that at this pace, the Centre will have to transfer about a third of the full year’s devolution sum in March.