Horizontal Tax Devolution

Horizontal tax devolution is the distribution of the states’ collective share of Union taxes among individual states. While vertical devolution determines how much of the divisible pool goes to all states together, horizontal devolution determines each state’s percentage of that collective share.

Constitutional basis and allocation process

Article 270 provides for sharing specified Union taxes between the Union and the states. Under Article 280, the Finance Commission recommends both the Union-state distribution and the allocation among states.

• The divisible pool consists of the net proceeds of shareable Union taxes; constitutionally excluded receipts, including specified-purpose cesses and Union surcharges, are outside it.
• A state’s tax-devolution entitlement is calculated by multiplying the aggregate amount available for all states by that state’s recommended horizontal percentage.
• The allocation is formula-based, rather than a direct refund of taxes collected within each state.

How the horizontal formula works

The Finance Commission selects indicators, assigns weights and combines states’ relative positions on those indicators into percentage shares. These criteria and weights can change between commissions; they are not permanently fixed by the Constitution.

• Income distance measures a state’s income gap from a higher-income benchmark, giving greater weight to states with lower per capita incomes.
• Population and area represent expenditure needs associated with the number of residents and geographical size.
• Forest and ecology recognises the ecological services and constraints associated with maintaining forest cover.
• Demographic performance rewards progress in population stabilisation, while tax effort rewards stronger mobilisation of a state’s own tax revenue.

An illustration: the Fifteenth Finance Commission

For 2021-26, the Fifteenth Finance Commission used the following horizontal-devolution weights:

• Income distance carried a weight of 45%.
• Population, using the 2011 Census, carried a weight of 15%.
• Area carried a weight of 15%.
• Forest and ecology carried a weight of 10%.
• Demographic performance carried a weight of 12.5%.
• Tax and fiscal efforts carried a weight of 2.5%.

The federal balance

Horizontal devolution combines equalisation with recognition of expenditure needs and incentives for performance. Its central challenge is balancing support for poorer states with the concerns of states that have achieved higher incomes, stronger revenue mobilisation or earlier population stabilisation.