Fiscal capacity
Also called: Tax capacity · Topic: Fiscal Federalism: Finance Commission, Devolution and Centre-State Finances · NCERT: Beyond NCERT
Meaning
Fiscal capacity is a government's ability to raise money from its own tax base. A state with richer people and more business can collect more tax, even at the same tax rates. It is usually measured by per capita GSDP (Gross State Domestic Product per person, the state's income per person). It matters because states with low fiscal capacity cannot fund the same schools, hospitals and roads without help from the Centre.
Example
Per capita GSDP differs several-fold between high-income states such as Goa, Sikkim, Telangana, Karnataka and Haryana and low-income ones such as Bihar, UP and Jharkhand. So Bihar raises far less tax per person than Goa. This is why Finance Commission formulas give poorer states a larger share of central taxes.
Don't confuse with
- Tax effort: fiscal capacity is how much a state could raise from its base. Tax effort is how much it actually collects compared with that base.