With the Narendra Modi-led government's first full budget due this weekend, it Tuesday accepted the recommendations of the 14th Finance Commission for a record increase of 10 percent in the states' share of the divisible pool of central taxes.
In a letter to all chief ministers, Modi said: "We have wholeheartedly accepted the recommendations of the 14th Finance Commission, although it puts a tremendous strain on the Centre's finances."
"The 14th FC has recommended a record increase of 10 percent in the devolution of the divisible pool of resources to states," he said, according to a release from the prime minister's office.
As per the increased devolution suggested in the report of the 14th Finance Commission, the states will get Rs.348,000 crore in 2014-15 and Rs.526,000 crore in 2015-16.
"There is a shift from scheme- and grant-based support from the central government to a devolution-based support. Hence, the devolution of 42 percent of divisible resources," the PMO said.
"Beyond this 42 percent and the grants to states for strengthening gram panchayats and municipal bodies, an additional amount has been allocated for 11 states that will still be revenue deficit after devolution," Finance Minister Arun Jaitley told reporters here.
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"The big among these deficit states have been identified as Andhra Pradesh after division, Assam, Jammu and Kashmir, Himachal Pradesh and West Bengal while the smaller ones include some northeastern states like Manipur and Nagaland," he added.
After assessing the revenue and expenditure of the states for the period 2015-20, the commission has recommended a grant of Rs.1.94 crore (Rs.19.4 million) to meet the deficit of these 11 states.
"The higher tax devolution will allow states greater autonomy in financing and designing of schemes as per their needs and requirements," the report said.
"The consequence of this much greater devolution to the states is that the fiscal space for the centre will reduce in the same proportion," it added.
"States cannot become dependent on the Centre, while the command and control system of the past cannot work. It is this spirit of cooperative federalism that has underpinned the constitution of the NITI Aayog," Jaitley said.
"In the past, when Finance Commissions have recommended an increase, it has been in the range of 1-2 percent," he added.
The government has also accepted the recommendations of the commission on devolution of higher resources to the local bodies.
The total grant to the local bodies including panchayats and municipalities for the five-year period ending March 31, 2020 works out to Rs.288,000 crore.
The commission, headed by former Reserve Bank of India governor Y.V. Reddy, had a dissenting note from part-time member Abhijit Sen, who recommended devolution of 38 percent of the divisible pool in the first year.
The huge hike over the current 32 percent is a little short of the states' demand for a 50 percent share.
This is also the largest increase in tax devolution since the 7th Finance Commission doubled the states' share of excise duties from 20 percent to 40 percent in the 1980s.
The Commission has also asked the Centre to ensure that prevailing levels of transfers to states remain at around 49 percent of gross revenue receipts.
The total transfer was 39.5 percent in the case of the 13th Finance Commission.