What are horizontal and vertical tax devolution?

By Ritesh|Updated : September 7th, 2022

The Finance Commission (FS) is a constitutional body that determines the mode and formula for tax revenue distribution between the Centre and the States and between the States as per the constitutional arrangement and current requirements. Article 280 mandates that FC make suggestions about the distribution of tax revenues between the Union and the states and among the states.

Horizontal and Vertical Tax Devolution

According to the Constitution, the FC has broad powers to (re)define financial relations between the Union and the states.

  • The President of India constituted the 15th Finance Commission in November 2017 under the chairmanship of NK Singh.
  • Its recommendations will cover five years, from 2021-22 to 2025-26.

Vertical transfer (transfer of Union taxes to states):

  • It recommended keeping vertical transmission at 41% - the same as in its 2020-2021 interim report.
  • It is at par with 42% of the divisible pool recommended by the 14th Finance Commission.
  • It has required an adjustment of about 1% due to the status change of the former State of Jammu and Kashmir to the new union territories of Ladakh, Jammu, and Kashmir.

Horizontal transfer (distribution between countries):

  • For horizontal transfer, it suggested 12.5% weightage on demographic performance, 45% on income, 15% on population and area, 10% on forests and ecology, and 2.5% on taxes and fiscal effort.

Summary:

What are horizontal and vertical tax devolution?

The Constitution requires that each FC submit proposals for the division of net tax income, commonly known as vertical and horizontal devolution, between the Union and the states and among the states. Vertical transfer deals with union taxes transfers between the states, while horizontal deals with distributions between the countries.

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