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Distribution of
Tax, Revenue
Distribution
and Financial
of Fiscal
Equilibrium
Powers

Ms. Kalyani Buche

MA, LLM, PGDHR, SET 1
 Fiscal
Click to edit Master title style Federalism
• India has a federal form of government, and hence a federal
finance system.
• The essence of federal form of government is that the Centre
and the State Governments should be independent of each
provided with sources of raising adequate revenues to discharge
the functions entrusted to it.
• Fiscal federalism refers to the financial relations between the
country’s federal government system and other units of
government

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 Several Heads of Discussion under Financial Relation between
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Union and the State

Allocation
of Taxing
Powers

Fiscal Distribution
Grants-in-
of Tax
aid Federalism Revenue

Distribution
of Non-Tax
Revenue 3
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style
POWERS OF TAXATION
• Article 246 and Seventh Schedule of the Indian Constitution
distributes powers and allots subjects to the Union and the The main source of income for the Union are direct
states with a threefold classification type: taxes, mainly income tax. However, they are also
entitled to collect various other taxes such as customs
i. List I: The Union is responsible for and corporate tax – taxes other than agricultural
income, excise duties, customs and corporation tax.
functions of national importance,
including but not limited to
communications, constitution, defence,
elections, external affairs and organisation States normally derive their income from indirect
taxes, most commonly from sales tax. Besides this,
of the Supreme Court and the High State List also includes land revenue, excise on
Courts. alcoholic liquor, estate duty, tax on vehicles and more.
ii. List II: States are responsible for touching
on the life and welfare of the people, for
instance, through public order, police
force, agriculture, local government, The Concurrent List does not comprise any tax power.
The distribution of revenues and approaches for
public health, water land, etc. determining grants between the States and Union are
iii. List III: The Concurrent list includes the legislated by various Articles of the Indian
administration of justice, economic and Constitution.
social planning, and more.

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2. Distribution of Tax Revenue
A. Taxes levied by the Centre but Collected and Appropriated by the States (
Art. 268)
B. Service Tax levied by the Centre but collected and appropriated by the
Centre and the State (Art. 268A)
C. Taxes levied and collected by the Centre but assigned to the States (Art.
269)
D. Taxes levied and collected by the Centre but Distributed b/w Centre and
the State (Art. 270)
E. Surcharge on certain Taxes and Duties for purpose of the Centre (Art.
271)
F. Taxes levied and collected and retained by the State
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3. Distribution of Non-tax Revenue
A. The Centre : receipts from the major non-tax revenue of Centre like,
• Posts & Telegraph,
• banking, broadcasting,
• coinage and currency,
• PSUs
• Escheat & lapses
B. The State
 Irrigation
 Forests
 Fisheries
 State PSU
 Escheat & Lapses

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4. Grants-in-aid to State
• Statutory Grants (Art. 275) – empowers the Parliament to make
grants to the States which are in need of financial assistance and not
to every state
• Special Grants for the welfare of Scheduled Tribes can also be given or
to state consisting of Scheduled areas like Assam
• Discretionary Grants (Art. 282) – gives authority to C & S to make any
grants for any public purposes even if it is not within their legislative
competence (Under this the Centre used to give grants on the
recommendations of Planning Commission, making it more significant
than Finance Commission)
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Click to Changes
Recent edit Master
to the
titleIndian
style Fiscal Federalism Structure

In recent years, fiscal relations between the union and state governments have undergone significant
changes. Since 2015-2016, three landmark changes include:

1. The abolition of the Planning Commission in January 2015 and the subsequent creation of the NITI Aayog;
2. Fundamental changes in the system of revenue transfers from the centre to the states through the
provision of higher tax devolution to the states based on the recommendations of the Fourteenth Finance
Commission (henceforth, “14th FC”); and
3. The Constitutional amendment to introduce the Goods and Services Tax (henceforth, GST) and the
establishment of the GST Council for the central and state governments to deliberate and jointly take
decisions.
These changes and implementations have far-reaching consequences for the provision of public
services and the union-state fiscal relations.

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TaxClick to edit Master
Distribution titleCentre
between style and the State

Accordingly there are both mandatory and enabling provisions in the Constitution
for facilitating a wide-ranging transfer of resources, arranged in a systematic
manner, through
1) Levy of duties by the Center but collected and retained by the States.
2) Taxes and duties levied and collected by the Center but assigned in whole to the states
3) Mandatory sharing of the proceeds of income tax
4) Permissible participation in the proceeds of the Union excise duties
5) Statutory grants –in-aid of the revenues of states
6) Grants for any public purpose and
7) Grants of loans for any public purpose

Thus, having provided for a certain division of powers of taxation between the
union and the states, the Constitution gives the States a share in the resources
available to the Center.
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Click to Changes
Recent edit Master
to the
titleIndian
style Fiscal Federalism Structure

In light of constitution of the Fifteenth Finance Commission (henceforth, “15th FC”) and the
formulation of its Terms of Reference (henceforth, “TOR”), there have been rising concerns
centralling around the following:
a) The Finance Commission’s role in providing conditional and unconditional transfers to the
states;
b) The use of the transfer system to achieve development and policy outcomes; and
c) The future framework of state government borrowing.

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 Issues
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title style
Federalism Structure
Horizontal Imbalances
• Replacement of the Planning
Commission with the NITI Aayog - This
move has reduced the policy outreach
of the government as they now solely
rely on the finance commission, which
in turn, leads to a serious problem of
increasing regional and sub-regional
inequities
• Leading to increase in horizontal
imbalances because of the differing
levels of attainment by the states,
resulting from the differential growth
rates and their developmental status in
terms of the state of social or
infrastructure capital.
Vertical Imbalances
• Vertical imbalance arises due to the fiscal
asymmetry in powers of taxation vested with
the different levels of government in relation
to their expenditure responsibilities
prescribed by the constitution.
• In India’s fiscal federalism, the central
government has a far greater domain of
taxation Central Government collects around
60% of the total taxes, while its expenditure
responsibility is only 40% of the total public
expenditure.
• Such vertical imbalances are even sharper in
the case of the third tier consisting of elected
local bodies and panchayats.
• Vertical imbalances can adversely affect
India’s urbanization, the quality of local public
goods and thus further aggravating the
negative externalities for the environment and 11
climate change. 11
 Challenges
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titlefiscal
style federalism
• Fiscal federalism is the economic counterpart to political federalism.
• It assigns functions to different levels of government and also offers
appropriate fiscal instruments for carrying out these functions.
• Determination of these specific fiscal instruments is a challenging task.
• Building the principles into an actual scheme of assignment of taxes to different
levels of government in a Constitution is difficult.
• In India, income tax is levied only by the Central government though shared
with the States.
• Given the possibility of imbalance between resources and responsibilities,
many countries have a system of inter-governmental transfers.
• There is huge economic and cultural diversity among the various States. It is a
terrible mistake to presume that all of India can be governed from Delhi.
• Elected State governments and leaders cannot be made dummies without any
fiscal powers for long.
• This fiscal federalism tension between the Centre and States can erupt into
something more dangerous and spread wide.
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 Restructuring the Fiscal Federalism
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• India’s Fiscal Federalism needs to be restructured. By restructuring Finance Commission, NITI Aayog, GST and
decentralization, it can eliminate the inadequacies of vertical and horizontal imbalances.
 Finance Commission must be relieved from the dual task of dealing with the provision of basic public goods and services and
capital deficits. It should be confined to focusing on removal of basic public goods imbalance (Type I).
 NITI Aayog, for dealing in the realm of infrastructure and capital deficits (Type II).
 It should be engaged with the allocation of capital in a way different than that used by the Finance Commission with different
parameters for allocation. NITI Aayog should receive significant resources (1% to 2% of the GDP) to remove regional and sub-
regional disparities among states by reducing development imbalances in the areas of infrastructure deficit. NITI Aayog should
be mandated to create an independent evaluation office which will monitor and evaluate the efficacy of the utilization of
revenue and capital grants. It should also be an integral part of the decision making processes as it can effectively negotiate
between the states for the transfer of resources.
 Decentralization can serve as the new fiscal federalism by strengthening local finances and state finance commission.
 Local public finance: the creation of an urban local body or the Panchayati Raj institutions consolidated fund.
 Centre and States should contribute an equal proportion of their Central GST(CGST)and State GST (SGST) collections and send the
money to the consolidated fund of the third tier. One-sixth sharing of the CGST and SGST with the third tier can generate more
than 1% of the GDP every year for the financing of public goods by urban-level bodies.

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 • State FinanceCommissionsshould be accorded the same status as
the Union Finance Commission and the 3Fs of democratic
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decentralization (FUNDS, FUNCTIONS, AND FUNCTIONARIES) should
be implemented properly.

Goods and Services Tax should be simplified in its structure and by

ensuring:
Single Rate GST: with suitable surcharges on single goods, zero
ratings of exports and reforming the Integrated Goods and Services
Tax (IGST) and the e-way bill. GST is a comprehensive, multi-stage,
destination-based tax that is levied on every value addition. GST is
one indirect tax for the entire country. The GST council is the key
decision-making body that will take all important decisions regarding
the GST. The GST Council should undertake reforms in an informed
and transparent manner, by creating its own secretariat and
independent experts.

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Thank You

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