Centre- State Financial Relations in

India
(Fiscal Federalism)

Dr. Abdul Azeez.NP @ AMU

 Fiscal
Federalism
In India:
Provisions, Issues
& Recent Trends
Dr. Abdul Azeez N.P.
“We want to promote co-operative federalism in the country.
At the same time, we want a competitive element among the
states. I call this new form of federalism Co-operative and
Competitive Federalism”-

Prime Minister Narendra Modi

Dr. Abdul Azeez.NP @ AMU

 Fiscal Federalism
• Fiscal federalism relates to the division of government functions
and finances in a logical way among multiple layers of
government.

• Therefore, there is a definite division of powers and revenue

between central government and provincial (state) government.

• Over a period of time, the nature and scope of governments’

function has changed manifold.
Dr. Abdul Azeez.NP @ AMU
 Constitutional Provisions
Centre-State Relations
• Part XI of the Indian Constitution (Articles 245 to 263) deals with
the relations between the Union and the States.
• Seventh Schedule (Article 246) divides the distribution of law
making power into three lists:
 List I/the Union List –
Exclusive powers to Centre with respect to 100 items
 List II/ the States List –
Exclusive powers to State with respect to 61 items
 List III/ the Concurrent List –
Both the Union and the State have powers 52 items.
Dr. Abdul Azeez.NP @ AMU
 FISCAL FEDERALISM IN INDIA

Article 267 to 281 of Part XII of the Indian Constitution deal

with the Centre-state fiscal/financial relations and constitute the
heart of the debate on fiscal federalism in India.

Dr. Abdul Azeez.NP @ AMU

 Constitutional Aspects of Taxation
by the Union and States
• In respect of the subjects listed in the Union List Centre has the
exclusive power to make tax laws. There are 13 taxes which are
listed in the Union List.

• Similarly, for the taxes listed in the State List, States have
exclusive power to make laws. 19 taxes are listed in the State List.

• However, no taxes are listed in the Concurrent List.

Dr. Abdul Azeez.NP @ AMU

 Constitutional Aspects of Taxation
by the Union and States
1 Taxes levied by the Union but collected and appropriated by the
State (Art. 268)
2 Taxes levied and collected by the Union but assigned to the
States (Art. 269).
3 Taxes levied and collected by the Union, distributed between the
Union and the States (270)
4 Duties levied, collected and appropriated by the State

5 Duties levied, collected and appropriated by the Centre

Dr. Abdul Azeez.NP @ AMU

 1. Taxes levied by the Union but collected and appropriated by
the State (Art. 268)

2. Taxes levied and collected by the Union but assigned to the

States (Art. 269).
Taxes

3. Taxes levied and collected by the Union, distributed between the

Union and the States (270)

4. Duties levied, collected and appropriated by the State

5. Duties levied, collected and appropriated by the Centre

 Resources Transfer from Centre to State
In India, transfers from the Centre to States, comprising statutory and
non-statutory transfers, take place through three channels, namely

• Finance Commission
• Planning Commission and
• the Central Ministries
• The States get loans against the net small saving collections. These
are from the NSSF which is outside the Consolidated Fund of India
and cannot strictly be termed as loans from the Centre.
• Borrowings/ grand in aid Dr. Abdul Azeez.NP @ AMU
 Finance Commission

Planning Commission

Resources Transfer
Central Ministries
from Centre to State
Loans against the net small
saving

Borrowings/ Grand in aid

 Finance Commission
(Statutory transfers)
• It is a Constitutional body with the broad mandate to define the
centre-state fiscal relations.

• Its most important task is to recommend the division of tax revenues

collected by the Centre (excluding certain items such as cess) called
the “divisible pool” between the Centre and States and the share to be
allocated to each State.

• Under the provisions of the constitution, the president is required

under Article 280 (1) to constitute within two years from the
commencement of the finance year and there after the expiration of
every fifth year.
Dr. Abdul Azeez.NP @ AMU
 Statutory transfers
 Constitutional body
 Article 280
 Tax Devolution
 Planning Commission
(Non-Statutory transfers)

• Non-Statutory transfers in the form of plan grants take place

through the channel of the Planning Commission;

• Planning Commission set up by a Resolution of the

Government of India dated 15th March 1950 to make an
assessment of the material, capital and human resources of the
country, and to formulate a plan for effective and balanced
utilization of the country’s resources.

Dr. Abdul Azeez.NP @ AMU

 Non-Statutory transfers
 Resolution of the Government of India
 15th March 1950
 Plan grants
 Borrowings
• Article 292 of the Constitution empowers the Union Government to borrow upon the
security of the Consolidated Fund of India;

• The Union Government can borrow internally as well as externally;

• Article 293 States empowered to borrow;

• The borrowing powers of the States are limited;

• Furthermore, if a State is indebted to the Union (as every State is now), it may not resort
to further borrowing without the prior consent of the Central Government.

Dr. Abdul Azeez.NP @ AMU

Article 292 - Union to borrow

Article 293 - States to borrow

Grant in Aid
Issues in Fiscal Federalism

Dr. Abdul Azeez.NP @ AMU

Issues in Fiscal Federalism

Fiscal
Imbalances

Vertical Horizontal
Imbalance Imbalance
 Vertical Imbalance

Difference between expenditures and

revenues at different levels of governments.
 Vertical Fiscal Imbalance
• Matching of expenditure responsibilities and taxing powers, enabling each level of
government to be financially sufficient. The imbalance in this regard is termed to
as vertical fiscal imbalance.

• Vertical fiscal imbalance refers to the difference between expenditures and

revenues at different levels of governments.

• It arises when one level of government financial resources exceeding its needs,
while the other lacks sufficient resources to carry out its functions.
• This is a common feature of all multi-level governments.

Dr. Abdul Azeez.NP @ AMU

 Horizontal Imbalance

Existence of economic inequalities among the states.

Exist due to differing levels of capacity for

resource mobilisation by different States
 Horizontal Fiscal Imbalances
• It is referred as the existence of economic inequalities among the states;

• It refers to inter-state economic disparities resulting from differences in area,

climate, topography, soil and mineral ressources, factor endowments etc.

• Horizontal imbalances exist due to differing levels of capacity for resource

mobilisation by different States as their per capita income levels vary widely.

Dr. Abdul Azeez.NP @ AMU

 Fiscal Tensions
• With respect to tax revenue, states show discontent with the level of
their involvement in the decisions taken by the Centre.

• The States complaining that the resource transfers to them have not been
commensurate with their growing responsibilities.

• Growing regional imbalances both inter-State and intra-State (regional

imbalances) are matters of serious concern and are counter to the
objective of realising the goal of inclusive growth.

• The periodic pay revision by the Central Government gives rise to

demand on the part of State government employees for a similar pay
hike. Dr. Abdul Azeez.NP @ AMU
 Fiscal Tensions
• As against legislative/ executive supremacy of the Centre, much of the
criticism on Centre-state fiscal/financial relations and fiscal federalism
in India stems from the process of economic policy making.

• Some of it is due to the emergence of the Planning Commission of

India playing a dominant role in economic policy making and
disbursing a large sum of central funds to state governments as Non-
Plan expenditures.

• Unlike the Finance Commission of India, the backbone of Centre-state

fiscal/financial relations, the Planning Commission is a body not
envisaged in the Indian Constitution.
Dr. Abdul Azeez.NP @ AMU
 Dynamics of Centre-State
Fiscal & Financial Relations

Dr. Abdul Azeez.NP @ AMU

 Modi’s Effect on Centre-State
Fiscal/ Financial Relations
After a landslide victory in 2014 elections, Modi states that his
government is serious about restructuring Centre-state relations and
strengthening the principles of “co-operative federalism.”

• 14th Finance Commission Recommendation;

• Replacement of Planning Commission and
• Introduction of GST

Dr. Abdul Azeez.NP @ AMU

 Co-operative Federalism

 14th Finance Commission Recommendation

 Replacement of Planning Commission (NITI Aayog)

 Introduction of GST
 14th Finance Commission Recommendations
• The Fourteenth Finance Commission (FFC) was appointed on
2ndJanuary, 2013 under the chairmanship of Dr. Y. V. Reddy;
• The spirit behind the FFC recommendations is to increase the
automatic transfers to the states to give them more fiscal autonomy;
• The Union government accepted the recommendations;
• To share 42% of its net tax revenue with states which increased from
the existing 32%.

Dr. Abdul Azeez.NP @ AMU

 14th Finance Commission
 Constituted on 2 January 2013
 Chairman- Y.V. Reddy
 Came in to Force on April 2015

42 per cent
(2015-20)
12th FC – 30.5%
13th FC – 32.0%
 Importance of FFC
• The FFC recommendations are in line with the spirit of cooperative federalism;
• FFC has made far-reaching changes in tax devolution that will move the country
toward greater fiscal federalism, conferring more fiscal autonomy on the states;
• It is expected that with this change in the sharing pattern, concerns of the States of
asymmetry in fiscal federal relations will be addressed;
• It is hoped that the States will use the extra fiscal space available to them to create
productive capital assets;
• Every State stands to gain under the FFC.

Dr. Abdul Azeez.NP @ AMU

 NITI Aayog
(National Institution for Transforming India Aayog)
• Established by Replacing Planning commission on 1 January 2015

• First meeting of NITI Aayog was held on 8 February 2015.

• It is think-tank established by PM. Narendra Modi

• Aim- NITI Aayog's creation is to foster involvement and participation in the economic
policy-making process by the State Governments, "bottom-up" approach in decision-
making.

• It will provide opportunities to represent the economic interests of the State Governments
and Union Territories of India.
Dr. Abdul Azeez.NP @ AMU
 NITI Aayog
• Established on 1 January 2015

• It is think-tank in which every state

& UT has the right to set agendas

• Foster involvement & participation

in the economic policy-making
process by the State Governments.
 Importance of NITI Aayog
Centre-State Relations
• In NITI AAYOG the states are major role players;

• It is a think tank in which every state and UT has the right to set agendas;

• It promotes Co-operative Federalism, where co-operation among states is important for the
development of the region as well as for the nation.

• The states in a region can also make Regional Development Councils to tackle the problems that
are prevailing in a particular region;

• The states and UTs can decide what they want? And how much resources and funds they may need
to achieve their set goal;

• It has bottom-up approach which will also include village level planning in contrast to the top to
bottom approach;

• It will advise the government on social and economic

Dr. Abdul matters.
Azeez.NP @ AMU
The interaction between State Government and NITI
will shift in favour of interaction between the States and
Centre on program implementation after the FFC
recommendations as each State will now have more
space for determining its priorities and higher degree of
predictability of resources available.

Dr. Abdul Azeez.NP @ AMU

 GST and Centre-State Relation
• Currently, fiscal powers between the Centre and the States are clearly
demarcated in the Constitution;
• Introduction of the GST would require amendments in the Constitution so as
to concurrently empower the Centre and the States to levy and collect the
GST;
• The Constitution (122nd Amendment) Bill has now been introduced in the
16th Lok Sabha on 19.12.2014.
• GST Council (GSTC) would be constituted comprising the Union Finance
Minister, the Minister of State (Revenue) and the State Finance Ministers to
recommend on the GST rate, exemption and thresholds, taxes to be
subsumed and other features
• This mechanism would ensure some degree of harmonization on different
aspects of GST between the Centre and the States as well as among States.
Dr. Abdul Azeez.NP @ AMU
 GST came into effect from 1 July 2017

GST Council- Union Finance Minister, the Minister of State

(Revenue) and the State Finance Ministers
Dr. Abdul Azeez.NP @ AMU