Revenue-Sharing with the Linear Distance Criterion

The linear distance formula occupies a prominent position as an allocative criterion for revenue-sharing among State in India as well as internotionally. In India, the Tenth Finance Commission has preferred this criterion to other competing criteria and has given it a predominant weight. This poper analyses analytical properties of the alternative versions of the distance criterion. A generalised version of the distance formula has been developed and the alternative versions have been shown to be its special cases. Alternative criteria are compared in terms of their progressivity and equity. Some of the recent Finance Commissions in India have used an arbitrary adjustment in the distance criterion under political constraints. This politically constrained version does not satisfy the requirement of maintaining vertical equity consistently. An alternative, based on the general version, is proposed that Is progressive as well as satisfies equity. The distance criterion is also shown to be equivalent to a system of fiscal capacity equalisation grants under certain assumptions.