INTRODUCTION
Federalism is one of the key postulates of a democratic government, which seeks to limit centralisation and despotism. Indian federalism is a unique structure that has a centralising tendency, as it rests several legislative, economic, and other significant powers in the Union. In contrast, different units of government are placed in an unequal position. This unique approach to federalism has been shaped by the country’s pluralistic society and historical context, which moots the idea of national solidarity along with respect for regional diversity. Fiscal federalism is the epitome of the financial relationship measured via the distribution of economic elements such as taxes, expenses, transfer of funds, etc., between various constituent units of a federation. In the context of India, this concept often appears missing due to the vast centralised economic power in the Union, and the lateral introduction of the Goods and Services Tax has also boosted this centre-centric approach in Indian federalism.
FISCAL FEDERALISM IN INDIA: GENESIS AND CONSTITUTIONAL CONTEXT
The foundations of fiscal federalism in India could be traced back to the Government of India Act of 1919[1], providing separation between the centre and provinces in revenue matters[2]. Then, the introduction of the Government of India Act of 1935 paved the way for the distribution, transfer, and sharing of revenue between the Union and the states. The Constitution of India provides for a demarcated framework in respect of financial relations between the Union and the states under Part XII (Articles 268-293). Primarily, the division of legislative powers as to taxation could be inferred from the division of powers under Schedule VII[3]. The Union List grants exclusive power of taxation to the Union government in respect of customs duty, excise duty, tax on corporations, and transactions in stock exchanges, as well as the purchase and sale of goods in interstate transactions. Although the state list provides authority of taxation as to land revenue, income from agriculture, land, mineral rights, vehicles, luxuries, profession, and the sale and purchase of goods, the significant contribution to state revenue is made only by the taxes on the sale and purchase of goods.
Article 280 is the main facilitator of fiscal federalism, as it provides for the constitution of a Finance Commission by the Indian President every 5 years, which makes recommendations for the devolution of taxes, grants, and other aids[4]. It makes provisions for the vertical (between the centre & states) as well as horizontal distribution (among the states) of such revenue. Article 275 gives authority to Parliament to make laws for providing grants in assistance of revenue in favour of state(s), depending on various provisions, mainly the need for assistance[5]. Article 282 provides special power to both the Union and the states to make grants for public purposes, even for those matters which are not expressly provided to be legislated by them[6]. Article 293 puts limitations on the borrowing powers of states in the form of prior consent of the Centre when such states have outstanding loans from the Centre, which significantly affects the fiscal autonomy of states[7].
The scheme of arrangement of fiscal federalism completely underwent a radical change in 2017 with the enactment of the Goods and Services Tax (GST) by the 101st Constitutional Amendment[8]. It consolidated almost all indirect taxes into a single unified tax, whereby the power to levy sales tax by the states was surrendered in exchange for a share in GST. It is mainly divided into CGST (Intrastate), SGST (Intrastate), and IGST (Interstate), in which collection of CGST & IGST is done by the union, while SGST is collected by the state government.
CHALLENGES TO REALISATION OF THE FISCAL FEDERALISM IN INDIA
Fiscal federalism is an important player in shaping the governance and policy framework of a nation as a whole and also of its constituent federal units. However, the historical and constitutional arrangement, coupled with several other problems, has undermined the fiscal autonomy of states, acting against the principles of federalism. Some of the major challenges to fiscal federalism are as follows-
- Unequal Revenue Distribution- The 15th Finance Commission (2021-26) had recommended the share of states in central taxes to be 41% which is even less than the recommendations of the preceding commission (42%). Such a share is insufficient for states considering the expenditure incurred in respect of essential public services like education, healthcare, and rural development, which primarily fall within their domain.
- Dependence on Centrally Sponsored Schemes (CSS)- Recent trends have shown increased reliance on CSS to accommodate their economic vulnerabilities. These are the schemes or projects of the central government that are put into execution by the state governments, which earn them a proportional share of expenditure for such schemes. Also, the reduction in the sharing ratio in these schemes from 40:60 to 50:50 has enhanced the fiscal dependence of states on the centre [9].
- Goods and Services Tax (GST)- The introduction of GST has complicated the notion of fiscal federalism as states have been deprived of their authority to set taxes on their revenue sources, such as Value Added Tax (VAT) and entry tax. The distribution of GST is somewhat delayed every year, which worsens the cash flow problem of the states. Also, the presence of limited bargaining power in the GST council undermines the autonomy of the states in such taxation.
- Political Manipulation of Fiscal Resources– The vesting of substantial fiscal powers in the centre is always subject to political manipulations. The centralised decision-making provides arbitrary powers to the union without any limitations, which often leads to disagreements between the Union and the states. Often, the union government supports states that align with its ideology or politics, while the states governed by the opposition party have to face the wrath of the somewhat disproportional distribution of financial resources.
FISCAL FEDERALISM: WAY FORWARD
The distribution of economic powers and authority between the Union and state governments is crucial for effective, responsive, and inclusive governance policies. It is a complex matter in a modern democratic setup where states have to manage their finances without any help or interference from the Union. However, this fiscal independence is integral for addressing the unique and diversified challenges of a big nation like India[10]. For effective attainment of fiscal federalism in India, the following measures may be carried out:
- Enhancement of revenue share of states– The ever-decreasing share of states in the union revenue needs to be seriously addressed by the upcoming Financial Commission, keeping in mind the expenditure functions and policies undertaken by the states. The present percentage of revenue distribution is not sufficient to meet the various financial expenditures incurred by the states.
- Relaxation in Borrowing Restrictions– The rigid provision of prior assent of the Union in borrowings by the states hinders the financial autonomy of the states. Changes have to be undertaken in such provisions to ease loans and borrowings, particularly during financial crises, to enable higher fiscal flexibility. This flexibility is also critical for states receiving delayed loans and grants from the Union.
- Addressing GST Related Issues– GST has been a conflicting tax, often raising various ambiguities. Such anomalies must be addressed for its efficient use, equitable distribution between the centre and states, and proper realisation of its tax. Taxation authority to states must be granted in respect of more subjects that ensure their financial interest. Also, the distribution of such tax should be simplified and timely disbursed.
- Reduction of Cess and Surcharge Dependence– The Union government has the exclusive power to levy and collect cess and surcharges, which are not shared at all with the states. This arrangement needs to be transformed to ensure a more equitable and transparent distribution of revenues. These charges could supplement the revenue limitations of the states while ensuring national ambitions.
CONCLUSION
Federalism is one of the key elements of the Indian constitutional scheme. It originated from the British period, which favoured the Union, a tendency embedded in the Constitution (Articles 268-293, Schedule VII). While Indian federalism is peculiar in itself, it calls for a delicate power balance between the Union and its constituent units. The existing constitutional and legal measures are inclined towards the Union, which narrows the position of states, thereby impacting such an arrangement. The Finance Commission (Article 280) and intergovernmental grants (Articles 275, 282) establish frameworks for tax distribution and assistance, while Article 293 limits borrowing by states. The 2017 GST reform consolidated numerous indirect taxes, centralising tax control while distributing revenue through CGST, SGST, and IGST. Nonetheless, states face difficulties due to a restricted revenue share (41% of central taxes), excessive reliance on centrally sponsored programs, limited tax independence, borrowing limitations, and political favouritism in funding distribution. The decentralisation of somewhat inclined fiscal power distribution vested in the Union is the need of the hour for ensuring provincial autonomy and federalism in a true sense. Recommendations for reform include increasing the revenue share for states, relaxing borrowing limits, improving the design and timeliness of GST, and distributing cess and surcharge revenues to enhance fiscal autonomy and equity.
Author(s) Name: Sumit Kumar (University Five Year Law College, Jaipur, Rajasthan)
References:
[1] Government of India Act 1919
[2] M.M. Sury, Centre-State Financial Relations in India 1870—2010 (Indian Tax Foundation, New Delhi, 2008)
[3] Constitution of India 1950, sch VII
[4] Constitution of India 1950, art 280
[5] Constitution of India 1950, art 275
[6] Constitution of India 1950, art 282
[7] Constitution of India 1950, art 293
[8] 101st Constitutional Amendment Act 2016
[9] Vajiram Editor, ‘Fiscal Federalism, Constitutional provisions, Challenges, Finance Commission’s recommendations’ (Vajiramandravi, 25 January 2025) <https://vajiramandravi.com/upsc-exam/fiscal-federalism/> accessed 28 May 2025
[10] Staff, ‘Fiscal Federalism in India’ (Forum of Federations, 7 March 2016) <https://www.forumfed.org/document/fiscal-federalism-in-india/> accessed 29 May 2025
