How Declining Population Could Impact Finances Of Southern States

The five southern states--Andhra Pradesh, Tamil Nadu, Kerala, Karnataka and Telangana--have total fertility rates (TFR, or the number of children an average woman will have in her lifetime) below the national average. A low TFR is desirable, as it is linked to increased income per capita and lower poverty rates. It may also be temporary and not signal a serious population decline, according to sociologist and demographic researcher Sonalde Desai.

Source: National Family Health Survey, 2019-21; Demography, Health & Family Welfare report, Ministry of Statistics & Programme Implementation

*Note: Data for 1971 were not available for some states. Shown here are numbers for Bihar, Rajasthan and West Bengal from 1981; for Himachal Pradesh, Delhi, Goa, Arunachal Pradesh, Manipur, Meghalaya, Nagaland, Sikkim and Tripura from 1990-92; for Jharkhand, Jammu & Kashmir and Chhattisgarh from 2004; for Mizoram and Uttarakhand from 2005-06; and for Telangana from 2015-16.

However, policymakers and politicians in the southern states increasingly see their lower TFRs leading to a reduction in their share of the Union government’s pool of divisible taxes. In addition, their political representation in Parliament could decline following delimitation, an exercise due in 2026 after which the new boundaries of parliamentary constituencies will be determined based on the population.

In this explainer, we speak to experts on demographics and finance to understand these concerns.

Declining fertility, fewer people of working age in south India

The two data points that give rise to fears in the southern states are the difference in populations of states between 1971 and 2011, and the increase in the elderly population in south India.

The first figure is of concern because the combined population of Tamil Nadu, Kerala, Andhra Pradesh and Karnataka (known as Mysore until 1973) was nearly a quarter (24.7%) of India’s population as per the 1971 census. This number fell to 20.8% in 2011. (Telangana was carved out of Andhra Pradesh in 2014; hence the figures for AP include both states).

Population is one of the criteria that the Finance Commission (FC) considers for determining the inter-se (between states) division of taxes, according to Subhash Garg, former finance secretary and author of the book, We Also Make Policy.

The FC is a constitutional body that determines the transfer of taxes from the Union government to the states, called devolution of taxes. The term of the current one--the 15th FC--ends in March 2026.

“The central tax devolution kitty is distributed amongst the states to meet each state’s needs, taking into account their respective fiscal capacities and special cost disabilities [such as the increased spending for providing roads and electricity in hill states or special category states],” explained Garg. Any further gap between assessed needs of a state and post-devolution resources is met through a revenue deficit grant.

The highest weight (45%) in the tax transfer formula used by the 15th FC is assigned to “income distance”, which is the difference in per capita income of a state and that of Haryana, which was the richest state in the country in 2020-21 (not counting Sikkim and Goa). Population gets the second highest weight (15%) in the formula along with area.

To be fair to the states that have “done better on the demographic front”--that is, kept populations in check--the 15th FC also considered the TFR, giving states with lower fertility a higher share. Demographic performance was thus assigned a weight of 12.5%. The 14th FC used a combination of 1971 and 2011 populations to decide the tax transfer formula, a move which Garg calls an aberration.

“The whole system is designed to transfer larger resources to poorer states with higher populations. The southern states are fiscally better off and, with lower growth in population, their fiscal needs are also relatively smaller,” Garg said.

However, as Stalin wrote, fewer people of working age will result in fewer taxes being collected.

“Giving huge weightage on population (2011) will be an injustice to the states who have controlled the population,” believes Lekha Chakraborty, an economist at the National Institute of Public Finance and Policy and an expert on fiscal federalism.

In addition, an ageing population results in higher costs for healthcare and social security. This is what makes the proportion of elderly in the population contentious.

Kerala had the highest proportion of people aged 60 and above (12.55%) in 2011, followed by Goa (11.21%) and Tamil Nadu (10.41%). In Uttar Pradesh and Bihar, the proportion of the elderly was 7.7% and 7.4%, respectively.

However, this imbalance between the young and old population may correct itself when the couples who delay having children decide to do so, according to Desai. It could also be reversible. “Some of the low TFR is attributable to what demographers call “Tempo effect” where differences in fertility patterns between older and younger cohort create temporary low fertility that reverses over time.”

Taxation without representation

The five southern states together collected more than a quarter of the country’s direct taxes and 28.5% of its goods and services tax (GST), as per data presented in Parliament. On the other hand, they get 15% of the Centre’s pool of taxes as per the 15th FC.

States can also levy taxes for their own use, such as motor vehicle taxes levied by all states, or Kerala’s tax on aerated drinks. In addition, there are taxes levied and collected by the local bodies, such as property tax.

Ahead of each financial year, the Union finance minister presents a budget allocating funds for various ministries and central- or centrally sponsored schemes, grants, etc. This budget is debated in parliament and passed for implementation. In addition to the prospect of reduced share of taxes, the falling population of the southern states is projected to reduce their representation in Parliament once delimitation kicks in.

If the number of seats representing the southern states in Parliament falls after delimitation, they may also lose a say in how these taxes are spent. For instance, a 2019 analysis based on population projections for 2026 shows that by that year, Uttar Pradesh would be 11 seats short of the number of seats it required in parliament to adequately represent its population whereas Tamil Nadu would have eight seats in excess of that required to represent its population.

If the number of seats were to be revised such that no state has to lose any members of parliament, the Lok Sabha’s strength would be 848 seats, and Uttar Pradesh would have 143 seats (compared to 80 at present) while Kerala would have 20, the same as it has right now, the analysis shows.

If India’s parliamentary seats were to be reallocated on the basis of population, Uttar Pradesh, Bihar and West Bengal alone would make up a third of the parliament, as IndiaSpend reported in 2016.

In such a situation, the states are right to fear “taxation without representation”, believes Chakraborty. (The phrase was used as a rallying cry during the war between the British Empire and its US colonies.)

Balancing needs

States incur 60% of government expenditure in India. They are responsible for providing services such as healthcare and infrastructure to their residents. Against this, more than half of their revenues are from sources (central taxes, state goods and services tax, central grants and loans) that are outside their control.

After the changes in Union-state government financial relations--with the introduction of the GST and the 14th Finance Commission, which increased the share of tax devolution to states from 32% to 42%--states are losing autonomy on their finances and becoming more dependent on the Union government, as IndiaSpend reported in August 2024.

While the states are rewarded in some way for tax collection effort (such as state GST, which accrues to the states themselves), they are dependent on central transfers for about 18% of their total expenditure.

“Tax effort is an important variable in the tax transfer formula…” explained Chakraborty. The fifteenth FC was of the view that “the inclusion of tax effort as a criterion will reward the States with higher tax collection efficiency and, at the same time, will also encourage all States to be more tax efficient”.

Another recommendation that Chakraborty believes can address the concerns of the southern states is including the proportion of elderly in the population in the tax devolution formula.

However, Garg believes that the FC is only tasked with meeting the needs of the states. “FCs are not meant to reward states.”

Population size-based revenue distribution under FC should not be seen as resource sharing, according to Desai. “It is an investment in the future. The future of Southern states will depend, at least partially, on migration from the North. Ensuring these workers are well nourished and educated is good for the whole nation, not just the Northern states,” she explained.

IndiaSpend has reached out to Arvind Panagriya, chairman of the 16th FC, and the finance ministries of Tamil Nadu, Kerala, Telangana, Karnataka and Andhra Pradesh on the tax devolution formula suggested and terms of reference. This story will be updated when we receive responses.

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