74 .

I1r rI Io11 Econo11

- . - 5.Y.BA (Senr. IV) Paper _
11J
111
Introduction
·
Af ter rnd e~)C' nLkll cL' lndi.1 h,1,-; n1.1 ted ln r cl lcl tL'l'tl 1 ,,,1J.lll- Lu r e/ like .
USA and Canad
a, it\
which there i~ a c lL'.11' d lst i1Kl i () 1, I1,, 1\\ 'L'L' 1' I hl' Iu 11Ll iun :; nf Ihe Union ?overn men~a~d
,
State
. . , , . ,s tt' ff\ prov id es fo r a d1stnbut·
gov ernm cn ts ~111li 1lw1r ~LH trL·e:; u! n' \'L'll lll'. J. 1IL' 1L' L1t , 1..<1 I ,))-· · _ lot\
. · •
Jn d li lV1swn o l f7 L 1\ l' n rn w11l p Ln \' t'r b l'IW l'L' ll I 1w l~.( ' 11l 1.. 1I 111
L
. 1J the Sta le govern ment Th
• lls
.
lSSU~S requi i·ing u n i l l \1'11\il \ Lil rq : u l.1l H)II • , . •I c Central Govern ment anct
,ll l' p l,H'l'll U!IL 1Cl l I
J
an
locc, l affairs c1l'l' ll'l l l1) llw St.ill' l' ll \ ' l'l"ll l1 )C ll l S
0
,, · . , , . . . rnent to the Sta tes is an import
111C tr crn sln ,) I l\ 'S () U l\ '('!, l t'O l\1 the Cenl l'cl 1 u llV el l1 ant
.t . f ·· .
e a t Lll'L' <..l l11c lu 1c1 11ct,\l svslern l ) [. lnd1 .
c1 . Wll1.1e rcsow .ccs , ... of the Central go vernme nt yield
a.
1•
SU L1 Sl,ml 1 • l
,1 surp I11s , S, ta ll'- L',\ l\'l' l'lltlH; nh s11 ·r I I +cits Therefo re cl mechan ism.
l e r 11:·a vy <. e ~ L •
of·

~rans f c r l) f rL'S t) UffL' S frrnn ~ -lw ~\'nln' to the St;1 tes hds been pro vided by th e ConS titution.
. .
respons-•b'lt 1 1 1es of the States. Fi gur e •6.1
Tl wsc r0sou n.'cs hel p Ill the e,cculi on o( v,1r10us 't'
~
t.: >- }) l:nn~
· , tl1c process n(· tr,msfer · o1 resources fro - m i.11c C_en tJ·e to States and th e local Bodj e
\ s,

CENTRALG~ERNMENT]

UNION TERRITORIES
(Di.rectl y Contro lled b Centre)
~TATE GOVERNMENT

URBAN LOCAL RURAL LOCAL

GOVERNMENT GOVERNME NT
-> District Panchayat
Block Panchayat
I
, -> Village Panchayat
I

Fig. 6.1 : Transfer of Resources from the Centre to the States and Local Bodies

6~ PRAIS AL OF - UNION - GOVERNMENT -~l~RANS-FER- OF - FINAN CIAl.L

RESOU
r
RCES TO THE STATES
------------•-- --------------· - - -=.:-· - --- -- - - - ------= - - - ~
-

~ h e transfer of resources frorri the Cen tral Govern rnent to the Sta tes is an importa
nt
feature of the fin ancial sys tem of Ind i~While resources of ~he Centrnl govern ment
yield a
substan tia l surplus , State go vernme nfs suffer heavy defic its ., Therefo re c:1. mechan
ism of
transfer of resou rces from th e Cen tre to lhe States h as been ..rfovic.lPcl by the Cons
titutions.
Article 275 of th e constitu tion, on !he r1 d vice of the Fiuc.m lC Coimn ission, p ro
vides for
grants- in-a1d to the Sta tes in n eed of Jssistan ce. A rti cle 282 provide s for grants
by the
Union govern ment to the States for a ny p ublic pu rpose . This c.111 be fixed by the
Central
govern ment on its own discre tion. Fur ther th e State govern n1ents also borrow
from the
Centre to carry out the va rious develop mental an d reha bili tation program me's.
 pedt'al Finance and Transfer O .
'/Resourc
The Finance Co . es . 75
nun1ssion •
• The dist ribu rIon bet is required tO make rec ommend aho · ns on the following :
t axes and all . Wee n th D .
ocation betweene thenion and th states .
st t e of the net proceeds of shareable
• The principl a es of the states' share of divisible taxes '
Consolid t es that should govern gra . .
. a ed Fund of India and h n ts-m -aid of revenues of the states out of the
assistance, d of
• The mea s t e amount to be paid to the states in nee
ures nee d d
the resources of e toyats augment the C . . Fu.nd of a State to supplement
reco mm end t· pan cha (ru 1 onsohdated • · ··
ocal · ·
a ions mad e by the st ra 1
. gov ernments) m the state on the basis of
• The ate Finance Commissions
mea sure s nee ded t . ' .
the resources f _munici o augment the Conso~tda ted Fund of a State to supplement
Finance Co ~ palities
O n the basis of recommendations by the State
mm1ss1ons.
• Any oth er mat t " .- .;. . m .. . . .
Thus th e transfer er referred to the Com mtss 10n the interest of sound finance.
of
nsid ered und er th ree heareso urces fro m · th.e .·Centre to,·the, .· State gov ernm ent can be
c0 ds .
• Share in taxes and dut~es
• Grants and
• Loans
The mai n taxes sha d b . the
o re . etw een the Centre and · the State governments wer e
income tax and the Uni excise duties.
n
Income Tax . The · h U ·
· t personal income tax IS. · osed
· imp and collected by t e ruon
gov ern men t but the er
le 270 of the Con s:~ ti~roceeds are shar ed between the Centre and the States und
artic u on.

ance Comm·lSSi•on gave ,thei . ·· ·.

The Fin
Th· · , .r awa . . · two· bas1s
. . .rd on
vertical
1· d' ~ ~hare of the States In the total. collection of. income tax kno wn as
· ·
,1v1s1qn and
e in the .divisible poo l
2· The prin cipl e~ whi ch should govern the. sl;lare of each Stat
between states.
know-fl as hon zon tal division of resotµ"ces
t
s of income tax has vari ed from 55 per cen
The sh~ re of_ the stat es in ~h~ net proceed mis sion .
85 pei:cent und er the Nin th Finance Com
und er the Firs t Fin anc e Comm1ss1on to the net
sion recommended that 77.5 perc ent of
How eve r the Ten th Finance Commis Finance
be assigned to States. The Eleventh
proc~eds of taxe s on income sho uld tral
sion rec om men ded that the sha re of the States in the net proceeds of all Cen
Com mis .
dut ies be fixe d at 29.5 perc ent for ej;\c h of the five years from 2000-01 to 2004-05
taxes and
thts share to 30.5 percent.
The Tw elft h Fin~nce Com mis sion increased
bas is of the pop ulat ion and the relative
This distribution is done normally on the or till the
ulat ion was tl)e largest dete rmi ning fact
collectiop of the tax by the states. Pop from
of the pop ulat ion was bro ugh t dow n
Sixth Fin anc e Com mis sion . The wei ght . The
perc ent by the Seventh Finance Commission
75 per cen t in.t he Six th Com mis sion to 25 ulae for
changes. Firstly it qie d to unify the form
Ei;h th Fin anc e Com mis sion mad e two por tion of
tax and Uni on excise duti es. Secondly a
the inte r se dist ribu tion of bot h inco me States after
for dist ribu tion as per the deficits of the
th~ Uni on excise dut ies was kep t asid e
asse ss~ ~nt .
th Fin anc e Com mis sion intr odu ced tax effort by the state gov ernm ents as a
Th.e Ten
Ele ven th and the rwe lfth Finance
crit~rion for dist ribu tion of tax proceeds. The ity and fiscal efficiency. The ta x effo rt
es of equ
Com mis sion s hav e foll owe d the principl en th
ind ex o.f fisc al disc ipli ne wer e giv en a wei ght of 12.5 percent by the Elev
and the
6/S.Y.B .A.·-Indian Economy (Sem . IV) Paper-III
 76 Indian Economy - 5·Y·B·A · (Sem . IV) Paper
.
- Ill
·
F' · . . . t by the Twelfth Finance
mance Comm1ss1rm, which was increased to 15 percen t as given to th
C0 mmission. The largest weightage of 62.5 percent and SO perce~ w · C . . e
. . . . ·
in.come -d1stance cntenon introduced by the Eleventh an d Tw elfth Finance ·thomrruss1ons.
th h' h
1']u.s 1.s the d ifference
. _ f . ti State/States w1
ol per capita income of a State rom ie ·
e 1g est
per capita income.
dities and the distribution
Union Excise Duties: Excise duties are levied on commo b . f backwardn
is done in proportion to the population of the States and on th e ashis O b £. d t~ss
. . th state. T e num er o u 1es
o f the States m terms of the percentage of the poor in e . h S' th F'
sha red ino.·e;.:i sed fron.1 3 in the First Finance Commission to 45 m t ; ~x St tance
Com mi ssion. The Seventh Finance Commission raised the share O t ~ Th a;;. to
47.5 percent and brought alJ the Central excise duties under the divisible p(~o ·d the S mth
. ~ . . . C0 mmission raise e tates
tmancc Cornn11ss10n kept it at 45 percent. The Tenth Fmance
sh.1re to 47.5 percent to compensate them fo! the loss in income tax.

1. Additional Excise Duties

Tl1.ese d uhes· are · by · pursuanee of an agreement
levied the Central government m .
·1 eac l1e d b Y t h e National
· 956 B ·des the usual excise
Development Council in December 1 · esi · .
duties, the Central Government has been levying additional excise duties on ~oods of
· ·t ance m· mter-state
· · . trade and commerce .
nnpor hke sugar, to b acco, mi·n-made textiles. The
agreement allowed the states share in the additional excise duties levied by th e Centre on
these goods, for which the states were not allowed to levy excise duties.

2. Grants-in -Aid
The states are required to do important welfare and development functions by LiS t II
of the Seventh Schedule of the Indian Constitutiem. However the various tax resources
provided to the states are generally inelastic in nature and also inadequate. It was to
overcome this problem that the Constitution has provided for a mechanism of grants from
the Centre to the States. The principles for grants -in-aid to the revenues of the States have
evolved over time through recommendations of the Finance Commissions. As per Article
275 of · the Constitution, the Finance Commission decides about the grants-in-•aid to
States correspondin g to each five year plan.
1. Grants-in-aid may be given in the general form of aid to overcome current
revenue deficits or to correct inter-state disparities in resources.
2. Grants-in-aid may be given for specific purposes such as to develop education in
a backward region or improving administration like disqict administratio n, police
administration, fire services, judicial administration, heritage protection and so
on.
The distribution of grants is largely based on budgetary needs, tax efforts, and
economy in expenditure, obligations and purposes of national importance . The main
purpose is to correct the disparities in the availability of administrati ve and social
services between the developed states and the less developed states.
Every Finance Commission till the Sixth Finance Commission increased the amoubt
of grants-in-aid to the states. The Seventh and the Eighth Finance Commission s reversed
this trend by giving larger devolution of tax revenues to the states. Both the commissions
raised the states' share of income tax to 85 percent and excise duties to 45 percent. The
Ninth and tenth Finance Commissions calculated Plan as well as non-plan deficits. The
total amount of grants pn~vided by the Tenth Finance Commission was t 20,300 crores in
way of grants-in-aid, upgradation grants, grants to solve special problems of states,
calamity relief, and grants to local bodies.
Federa l 1: mance and T1ansf
.
er of R
esources
t) Loa ns by the C
. The Stat e gov entr e to the States·
states incr ease d froern~en ts were fac·· 77

finance Co~m issi on m" 195 ing

d• r·e crores to ~ 900the burd en of debt. The Centre's loan
com s to the
JJle m~ -ter m loan at th men ded two loancror s a
es fr
e om 1951 by
Mar ch 1955
fifth Finance Cornn-.. . e rate at Which th . The Second
-'-l.liss1on re y ar to the states, a long - term loan and a
manage t l1fir affairs commended the cent t th
re was bo
rrow
· fr
mg om the market. The
an elab orat e stud y o::h a matter of fiscal di~ i
l~ st~tes s~ould ?alance their budgets and
and exte ndin g the e deb t position of th pt ne. fhe Sixth Finance Com
reco nun end ed a mission made
hrepayment over 15 t e3s0ates and recommend
sc eme f O ed the consolidation
perforn1ance. The Elev ent~ F?eneral debt relieyears. The Tenth f c · ·
odificat ions Th f to all states lin~ ~c~ o ~m_m1sf:1on1
tnan
in . e com mis sion ob ce Comm1ss1 . .
on continued the scheme with eu isca
wo~ ld dep end on the fiscal im r served that certain
the qua ntum of relief availabl e to the states
penod. The Tw~ lfth Com mis . P ovement that
may be effected by the states during the
worst for stat es· due to a sion_observed that
the period from 1997-98 to 2002-03 was the
21.73 per cen t to 311 5 s1larp increase in the
Debt-Gross State Domestic Product from
prop orti.on of the GD · perc ent Th
P b'
· e com med debt of the Centre and the Stat
Twelfth Fin anc e Comm·ro~e from 56 .S percent es as a
in 1996-97 to 82.5 percent in 2004-05.The
and reso rt to mar ket bission .asked the states
to reduce their dependenc e on the Centre
availabl e for the stat orrowi~gs. It suggeste
d that the debt-relief sche me to be made
respons ibil ity. es only if, the states enacted the prescribed
legis lation for fiscal
The tota l tran sfer f
st
4 34 905 40 ° res.o~rces from the Centre to the states
wa ' ' · cror es. This increased to~ 7,55,751.62 crores during the period 2000 -05
for 2005 -10.
Bet tles the ann u~l bud geta ry process, since 1950
, India has follo wed a system of fiv e
year ~ ans for ens urin g long-term economic
objectives. This process is steered by the
Plan ning Com mis sion for whi ch there is no
specific provision in the Constitu tion. The
mai n fisc al imp act of the plan ning process is
the division of expe ndit ures into plan and
non -pla n com pon ents . The plan components
relate to items dealing with long-term
soci oec ono mic goa ls as dete rmi ned by the
ongoing plan process. They often relate to
specific sch eme s and projects. Furthermore,
they are usually routed thro ugh centra\
ministr ies to stat e gov ernm ents for achievin
g certain desired objectives. These funds are
gen eral ly in add itio n to the assi gnm ent of
cenh·al taxe s as dete rmi ned by the Finance
Com mis sion s. In som e cases, the state governm
ents also contribute their own funds to lhe
sche mes .
The pla nne d dev elop men t of a cou ntry requ
ires ?row i~g exp end itur es. Ther~ is a
nee d to incr ease larg er reve nue s for the governm
ent. It 1s easier for the Centre rathe1 than
the Stat es, to rais e reve nue s. The Finance Com
mission transfers some re: ern.H'. f~?m the
Cen tre to the Stat es. Thi s is don e periodically
every five years. Thu s there 1s flexlblhty and
elas ticit y in the amo unt tran sfer red to the Stat
es. . . ~ . .·
. . d 'des on these transfers on the basis
The Fin anc e Com mis sion eci of changing cnte1 ia
. . issi on The com plai nt against such criteria · · h F
with eve ry Fin anc e Com m lS that t e rnanc_t
. ·. h th t tes
. .
com mis sion mak es up the deficits t at e s a - incur in the imp lementation of the1
. . t mak e a •udgement rega rdin g the wastetu -
pro gra mm es. Th F . nee Com m1s s10n can no 1
e 1na . f th States Therefore the awa rd of the Fm .
. f the exp end itur e o e · anc
or pop ulis t nat ure o . '
h ality of exp end itur e of the States. There .bas bee'.1
Commis sion doe s not imp rov e t e qu 1 nne
d transfers and non -pla n revenue tran~h~ ·
felt nee d for co-o rdin atio n betw een p a i'\
, j l ~ I"'... .
from the Cen tre to the Stat es. 1 ()
-- - ~~ _..., IT"TT T; 'T'U TDT l:.'l:.'1\..TT