<p>India’s fiscal federalism hinges on the constitutional promise of equitable resource distribution between the Centre and the states. Article 275 of the Constitution empowers the Finance Commission (FC) to recommend grants-in-aid to states whose revenue accounts remain in deficit after tax devolution. </p><p>Over successive decades, FCs have played a pivotal role in shaping the fiscal contours of the Union-state relationship, seeking to balance both vertical (Centre-state) and horizontal (inter-state) equity. However, Karnataka’s experience under this regime reveals structural and procedural imbalances that have systematically disadvantaged fiscally responsible and economically dynamic states like itself.</p>.<p>Karnataka’s trajectory reflects a paradox. While the state has consistently demonstrated prudent fiscal management – through early adoption of the Fiscal Responsibility Act in 2002 and years of self-imposed deficit control – it has not been adequately rewarded under FC transfers. The 11th and 12th Finance Commissions coincided with Karnataka’s initial reform efforts. Although the 12th FC set a target of eliminating state-level revenue deficits by 2008-09, Karnataka had already made notable progress, relying less on FC aid and more on its revenue buoyancy from sales tax, VAT, and GST. Notably, Karnataka did not receive significant revenue-deficit grants during this period, implying that it was largely self-sustaining – an outcome that ironically excluded it from intergovernmental compensations.</p>.<p>By the time of the 13th FC, Karnataka had achieved a revenue surplus, continuing this trend into the 14th FC period, which saw a historic increase in states’ share of Central taxes to 42 per cent. Karnataka’s improved share of tax devolution during this phase (61per cent increase) briefly seemed to align reward with performance. Yet, the 15th FC reversed this trajectory. Despite facing pandemic-induced revenue pressures like all states, Karnataka was denied initial post-devolution revenue-deficit grants in 2020-21 on the grounds of projected fiscal balance.</p>.<p>When the fiscal reality worsened in 2021-22, Karnataka received a modest Rs 1,631 crore – far short of the Rs-19,486 crore revenue deficit it incurred in 2020-21. More galling was the Centre’s refusal to release a compensatory grant of Rs 5,495 crore recommended by the 15th FC to offset the sharp fall in Karnataka’s share from 4.71 per cent to 3.64 per cent of the divisible pool.</p>.<p>This situation stems largely from changes in the FC’s horizontal distribution criteria. The 15th FC’s shift towards newer parameters – such as “income distance” and “demographic performance” – disadvantaged high-performing states like Karnataka, which have higher per-capita incomes driven by sectors like IT and services. Ironically, the very success that allows Karnataka to contribute nearly Rs 4 lakh crore annually to the national exchequer acts against it in FC calculations. Meanwhile, the weight assigned to forest cover (raised from 7.5 per cent to 10 per cent) does little to benefit Karnataka due to its lower forest area compared to other states – despite its active urban afforestation and ecological spending. Additionally, Karnataka’s demand that cesses and surcharges be included in the divisible pool has been ignored, further shrinking its share.</p>.<p><strong>Reform without reward</strong></p>.<p>Karnataka’s fiscal strain is not merely due to formulaic bias but also arises from ambitious welfare programmes and political economy pressures. Flagship schemes such as free electricity, financial guarantees to farmers and women contribute to rising committed expenditures. However, rather than retreating from social commitments, Karnataka has responded with fiscal innovations. It has broadened its GST base, sought to monetise idle government land, and tapped into FC-permitted incentives such as extra borrowing space tied to reform milestones – especially in reducing power sector losses and leakages.</p>.<p>Despite these efforts, Karnataka’s repeated appeals for equity have largely gone unheeded. Its demand for greater weight to “tax effort,” recognition of states’ contribution to the national GDP, and fairer treatment of service-heavy economies remain unmet. In multiple communications during 2023–24, Karnataka’s leadership pressed for the release of the unpaid Rs 5,495 crore and lobbied the nascent 16th FC to rethink the formula architecture. Their proposal calls for structural correctives: a redistribution mechanism that not only addresses backwardness but also rewards fiscal discipline, economic contribution, and policy innovation.</p>.<p>Karnataka’s case is not just about a missed grant or an overlooked formula tweak. It challenges the deeper logic of India’s fiscal federalism – where equity should not be a zero-sum game and where performance should be incentivised rather than penalised. If India is to preserve cooperative federalism in spirit and substance, its most fiscally responsible states must not be left carrying the burden without receiving their fair share. Karnataka’s demand is not for charity – it is for fairness.</p>.<p><em>(The writer is an associate professor at the Department of Economics, Christ University)</em></p>
<p>India’s fiscal federalism hinges on the constitutional promise of equitable resource distribution between the Centre and the states. Article 275 of the Constitution empowers the Finance Commission (FC) to recommend grants-in-aid to states whose revenue accounts remain in deficit after tax devolution. </p><p>Over successive decades, FCs have played a pivotal role in shaping the fiscal contours of the Union-state relationship, seeking to balance both vertical (Centre-state) and horizontal (inter-state) equity. However, Karnataka’s experience under this regime reveals structural and procedural imbalances that have systematically disadvantaged fiscally responsible and economically dynamic states like itself.</p>.<p>Karnataka’s trajectory reflects a paradox. While the state has consistently demonstrated prudent fiscal management – through early adoption of the Fiscal Responsibility Act in 2002 and years of self-imposed deficit control – it has not been adequately rewarded under FC transfers. The 11th and 12th Finance Commissions coincided with Karnataka’s initial reform efforts. Although the 12th FC set a target of eliminating state-level revenue deficits by 2008-09, Karnataka had already made notable progress, relying less on FC aid and more on its revenue buoyancy from sales tax, VAT, and GST. Notably, Karnataka did not receive significant revenue-deficit grants during this period, implying that it was largely self-sustaining – an outcome that ironically excluded it from intergovernmental compensations.</p>.<p>By the time of the 13th FC, Karnataka had achieved a revenue surplus, continuing this trend into the 14th FC period, which saw a historic increase in states’ share of Central taxes to 42 per cent. Karnataka’s improved share of tax devolution during this phase (61per cent increase) briefly seemed to align reward with performance. Yet, the 15th FC reversed this trajectory. Despite facing pandemic-induced revenue pressures like all states, Karnataka was denied initial post-devolution revenue-deficit grants in 2020-21 on the grounds of projected fiscal balance.</p>.<p>When the fiscal reality worsened in 2021-22, Karnataka received a modest Rs 1,631 crore – far short of the Rs-19,486 crore revenue deficit it incurred in 2020-21. More galling was the Centre’s refusal to release a compensatory grant of Rs 5,495 crore recommended by the 15th FC to offset the sharp fall in Karnataka’s share from 4.71 per cent to 3.64 per cent of the divisible pool.</p>.<p>This situation stems largely from changes in the FC’s horizontal distribution criteria. The 15th FC’s shift towards newer parameters – such as “income distance” and “demographic performance” – disadvantaged high-performing states like Karnataka, which have higher per-capita incomes driven by sectors like IT and services. Ironically, the very success that allows Karnataka to contribute nearly Rs 4 lakh crore annually to the national exchequer acts against it in FC calculations. Meanwhile, the weight assigned to forest cover (raised from 7.5 per cent to 10 per cent) does little to benefit Karnataka due to its lower forest area compared to other states – despite its active urban afforestation and ecological spending. Additionally, Karnataka’s demand that cesses and surcharges be included in the divisible pool has been ignored, further shrinking its share.</p>.<p><strong>Reform without reward</strong></p>.<p>Karnataka’s fiscal strain is not merely due to formulaic bias but also arises from ambitious welfare programmes and political economy pressures. Flagship schemes such as free electricity, financial guarantees to farmers and women contribute to rising committed expenditures. However, rather than retreating from social commitments, Karnataka has responded with fiscal innovations. It has broadened its GST base, sought to monetise idle government land, and tapped into FC-permitted incentives such as extra borrowing space tied to reform milestones – especially in reducing power sector losses and leakages.</p>.<p>Despite these efforts, Karnataka’s repeated appeals for equity have largely gone unheeded. Its demand for greater weight to “tax effort,” recognition of states’ contribution to the national GDP, and fairer treatment of service-heavy economies remain unmet. In multiple communications during 2023–24, Karnataka’s leadership pressed for the release of the unpaid Rs 5,495 crore and lobbied the nascent 16th FC to rethink the formula architecture. Their proposal calls for structural correctives: a redistribution mechanism that not only addresses backwardness but also rewards fiscal discipline, economic contribution, and policy innovation.</p>.<p>Karnataka’s case is not just about a missed grant or an overlooked formula tweak. It challenges the deeper logic of India’s fiscal federalism – where equity should not be a zero-sum game and where performance should be incentivised rather than penalised. If India is to preserve cooperative federalism in spirit and substance, its most fiscally responsible states must not be left carrying the burden without receiving their fair share. Karnataka’s demand is not for charity – it is for fairness.</p>.<p><em>(The writer is an associate professor at the Department of Economics, Christ University)</em></p>
