Constitutional architecture of taxing and sharing: the divisible pool

Detail

1. The basic idea: taxing power and spending needs do not match

• Fiscal federalism means the split of taxing powers and spending duties between the Centre and the states.
• The Constitution gives the buoyant taxes to the Union. These are taxes whose revenue grows quickly as the economy grows, such as income tax, corporation tax and customs.
• The states carry most spending duties: police, health, agriculture and schooling.
• This gap is called vertical fiscal imbalance. It is closed in three ways:
• Tax sharing through the divisible pool (Art. 270).
• Grants-in-aid (Art. 275).

• Both are recommended every five years by the Finance Commission (Art. 280).

• Art. 293 limits state borrowing. A state that owes money to the Centre needs the Centre's consent to borrow more.

2. Who can levy which tax (Seventh Schedule)

• The Seventh Schedule has three lists. Tax entries sit in the Union List (List I) and the State List (List II). The Concurrent List has no tax entries.

Union List (entries 82-92C)	State List (entries 45-63)
Tax on income other than agricultural income	Land revenue
Corporation tax	Tax on agricultural income
Customs duties	Excise on alcohol for human consumption, opium, narcotics
Excise duties (now mostly on tobacco and petroleum)	Stamp duty on documents not in the Union List
Taxes on capital value of assets, etc.	Taxes on electricity consumption, vehicles, entertainment (by local bodies)
	Tax on professions, trades and employment (Art. 276: cap ₹2,500 a year)

• Agricultural income can be taxed only by the states. The Union's income tax leaves it out. This is a common MCQ trap.
• Professions tax (Art. 276): a state can charge a person at most ₹2,500 a year. Only a constitutional amendment can raise this cap.
• Residuary power: any tax not named in any list belongs to the Union (Art. 248, List I entry 97).

• Contrast: in the USA, residuary power lies with the states.

• GST and Art. 246A (101st Amendment, 2016):

• Parliament and state legislatures both have power at the same time to make GST laws. This is new "concurrent" taxing power that sits outside the three lists.
• Only Parliament can tax inter-state supplies. That tax is IGST (Integrated GST).
• The same amendment created the GST Council (Art. 279A), a joint body of the Union and the states that recommends GST rates and rules.

3. The distribution articles (Part XII, Chapter I)

Read these as a ladder. It runs from "state keeps everything" to "Union keeps everything".

Article	What it does	Who keeps the money
268	Duties levied by the Union but collected and kept by states (stamp duties on bills of exchange, cheques, etc.)	States
269	Taxes levied and collected by the Union but assigned to states (taxes on inter-state sale and on consignment of goods)	States
269A	GST on inter-state supplies (IGST). Levied by the Union and apportioned between the Union and states as Parliament provides on the GST Council's advice	Split
270	All other Union taxes are shared with states	Split, as the Finance Commission recommends
271	Surcharges on Art. 269/270 taxes	Union only
272	Omitted (80th Amendment)	—
273	Grants in lieu of export duty on jute to Assam, Bihar, Odisha and West Bengal	States named
285-289	Inter-governmental tax immunities (Union property is exempt from state taxes and vice versa, with exceptions)	—

How Art. 270 changed over time

• Before 2000:
• Only income tax had to be shared.
• Union excise could be shared if Parliament chose (old Art. 272).

• States got nothing from growth in customs or corporation tax.

• 80th Amendment (2000):

• Based on the 10th Finance Commission's "alternative scheme".
• States now get a share of all central taxes. So the old Art. 272 was dropped.

• Benefit: states share in the whole tax base, and the Centre has less reason to favour one tax over another.

• 101st Amendment (2016): brought CGST (Central GST) and the Union's portion of IGST into the shareable taxes.

• What Art. 270 leaves out: Art. 270 shares all Union taxes except those under Arts. 268, 269 and 269A, surcharges, and "any cess levied for specific purposes" under a law of Parliament.
• Since the Constitution itself leaves them out, the Centre has no duty to share cess or surcharge revenue with states [4].

Key terms

• Surcharge: an extra tax charged on top of an existing tax. Example: an extra percentage on the income tax of very high earners. Under Art. 271 it goes only to the Union.
• Cess: a tax raised for a named purpose, such as the Health and Education Cess or the Road and Infrastructure Cess. The money is meant for that purpose only.

4. The divisible pool

• Divisible pool: the part of the Centre's gross tax revenue that is shared with states.
• Formula:

• Divisible pool = Gross tax revenue − cesses − surcharges − cost of collection (and taxes of Union Territories).

• Gross tax revenue (GTR): all taxes the Centre collects, before anything is passed to states.

• Cost of collection: what it costs the tax departments to collect the tax.
• The Finance Commission fixes the share of this pool that goes to states. This is called vertical devolution, and it is the "41%".
• History of the vertical share:
• The 13th FC gave states 32%. The 14th FC raised this to 42% for 2015-20 [6].
• The 15th FC set 41% for 2021-26. The 1% cut reflects the change of Jammu and Kashmir into Union Territories [5].
• The 16th FC (Chair: Dr. Arvind Panagariya) submitted its report on 17 November 2025. It was tabled in Parliament on 1 February 2026. It kept the states' share at 41% for 2026-27 to 2030-31 [2][3].

• The 16th FC also restates the definition: the divisible pool comes after excluding cost of collection, cesses and surcharges from gross tax revenue [2].

• Horizontal devolution means how the 41% is divided among the states. The 16th FC's weights (2026-31) are [2]:

• Income distance: 42.5%
• Population (2011 Census): 17.5%
• Demographic performance: 10%. This now measures population growth from 1971 to 2011, not change in fertility rate.
• Area: 10%
• Forest: 10%. This counts both each state's share of forest area and its share of the increase in forest area from 2015 to 2023.

• Contribution to GDP: 10%. This is a new criterion.

• Grants-in-aid recommended by the 16th FC total ₹9.47 lakh crore for 2026-31 [2]:

• Rural local bodies: ₹4.35 lakh crore.
• Urban local bodies: ₹3.56 lakh crore.
• Disaster management: ₹1.55 lakh crore.

Worked example (made-up numbers)

• Gross tax revenue = ₹100 lakh crore.
• Cesses + surcharges = ₹15 lakh crore. Cost of collection = ₹1 lakh crore.
• Divisible pool = 100 − 15 − 1 = ₹84 lakh crore.
• States' share = 41% × 84 = ₹34.4 lakh crore.
• As a share of gross tax revenue: 34.4 ÷ 100 = 34.4%, not 41%.
• If cesses and surcharges rise to ₹20 lakh crore, the pool becomes ₹79 lakh crore. States then get ₹32.4 lakh crore, which is only 32.4% of GTR.

5. Why the headline "41%" misleads

Cesses and surcharges are growing, and they are not shared

• Mechanism:
• The Centre raises more money through cesses and surcharges instead of basic tax rates.
• That money stays out of the divisible pool.

• So states get a smaller slice of what the Centre actually collects.

• Trend:

• Cess and surcharge share of the Centre's GTR rose from 2.3% (1980-81) to 15% (2019-20) [4].
• It stayed above 15% between 2020-21 and 2022-23 [8].

• (NCERT scaffold: about 10% in the early 2010s, rising to about 18-20% at the 2020-22 peak. PRS gives the lower "over 15%" figure for 2020-23, so the exact peak depends on how GST items are counted.)

• Size (2019-20):

• The Centre collected ₹3,69,111 crore through cesses and surcharges.
• Only about 85% of GTR could form the divisible pool.
• If cesses and surcharges had been in the pool, states would have received about 5% more revenue [4].

The effective share is lower than the headline share

• 2019-20: the 14th FC's 42% share was effectively only 35.7% of the Centre's tax receipts. This calculation leaves out GST items such as IGST and compensation cess [4].
• 2020-21: states' share of the Centre's GTR was about 29%, against the 41% headline share [7].
• (NCERT scaffold: about 30-32% in recent years.)

GST compensation cess

• Started in 2017. It was charged on luxury and "sin" goods.
• It was used to pay states for revenue they lost when GST began.
• It also sat outside the divisible pool (see §7 of the parent note).

States' demand

• Cap cesses and surcharges at a fixed share of GTR, or
• Bring them into the divisible pool.

• Removing the exclusion for cesses and surcharges would need an amendment to Art. 270/271.

• Cess definitions and rates are covered in the taxation topic.

Prelims Hooks

• Divisible pool = Gross tax revenue − cesses − surcharges − cost of collection. Union Territory taxes are also left out.
• The 16th Finance Commission (Chair Arvind Panagariya, period 2026-31) kept states' share of the divisible pool at 41%, the same as the 15th FC [2].
• Art. 271: surcharges go exclusively to the Union. Cesses "for specific purposes" are also outside Art. 270 sharing.
• 80th Amendment (2000) brought in the 10th FC's alternative scheme: states share all central taxes. It also deleted Art. 272.
• Art. 268 = levied by Union, collected and kept by states (stamp duty on cheques and bills of exchange). Art. 269 = levied and collected by Union, assigned to states. Do not mix these up.
• Art. 246A gives Parliament and state legislatures simultaneous GST power. IGST on inter-state supply is for Parliament only (Art. 269A).
• Residuary taxing power lies with the Union (Art. 248, List I entry 97).
• Art. 276 caps professions tax at ₹2,500 a year. Agricultural income tax is a state subject.
• Art. 273 gives grants in lieu of jute export duty to Assam, Bihar, Odisha and West Bengal.
• 16th FC horizontal criteria: income distance 42.5%, population 17.5%, and contribution to GDP 10%, which is new [2].

Mains Points

• Headline vs effective devolution:
• States are promised 41%, but they received only about 29% of GTR in 2020-21 [7].
• The reason is that cesses and surcharges took up over 15% of GTR in 2020-23 [8].

• This weakens the spirit of cooperative federalism. It is a strong case for a cap on cesses and surcharges, or for bringing them into the pool (GS-II/III).

• Trade-off for the Centre:

• Cesses give the Centre earmarked, flexible money for defence, roads and health.
• But they make the tax system more complex and cut states' untied funds.

• States are the level of government that delivers most public services, so this hurts service delivery.

• Design logic of the 80th Amendment:

• Sharing all taxes removed the Centre's reason to favour taxes it did not have to share.
• It also let states share in the growth of the whole tax base.

• The later rise of cesses has partly undone this aim.

• The GST era changed the architecture:

• Arts. 246A, 269A and 279A pooled indirect-tax powers in the GST Council.
• States gave up tax autonomy in return for a shared tax base and guaranteed compensation until 2022.
• As a result, states now rely more on Finance Commission devolution and grants.