India, as defined by the first article in the Constitution, is a “Union of States”. This union bases its existence on the principles of unity, democracy, and effective power-sharing. The essence of a unitary government lies in the division of powers amongst the Centre and the States, with pre-defined roles and duties to be followed by each. This division of power is called federalism, and it forms the very basis of the society that we live in today.
In a culturally and economically diverse country like India, the federal form of Government can be the most effective form of governance. Amidst this division of powers, the fiscal relations between the Centre and the States become very important to address. Since its independence in 1947, the country has had various commissions and committees that have addressed and provided numerous means and mechanisms to have smooth and efficient fiscal federalism in India.
EVOLUTION OF FISCAL FEDERALISM IN INDIA
The roots of federalism in India can be traced back to the times of Lord Mayo, the fourth viceroy of India (1869-72), who had started the process of financial decentralisation in India. The present structure had evolved from the late eighteenth century when the two landmark acts – The Government of India Act of 1919 and 1935, made a clear distinction between the subjects that will come under the Centre and the States, as well as the common subjects between the both. The Constitution of independent India was adopted in 1950, and it brought about a very fundamental change in the provisions of power-sharing through different lists (Union, State, and Concurrent) as mentioned under the Seventh Schedule, and reflected in Article 246 of the Constitution.
HISTORY OF CENTRE-STATE FISCAL RELATIONS
As a newly independent country, India under Nehru adopted a centralized approach of governance, with more subjects under the Union list and fewer subjects under the State list. This approach was put forward with the belief that a newly independent nation needs a strong Centre to develop and stabilize the economy. This mismatch and imbalance created conflict and disparities between the Centre and the States, which is reflected even today after seventy years of independence.
In 1991, the Government introduced economic reforms, which not only affected large numbers of people but also changed the Indian economy and society altogether. Throughout the years of reforms, and the period of recovery, the states were burdened with providing the basic amenities to the people. With the Centre having higher revenue potential, the states felt alienated and overburdened with the responsibilities, thus escalating further tensions between Centre and States.
THE FINANCE COMMISSION
The Finance Commission is a quasi-judicial body, independent of the Centre and the States, and working under the Finance Ministry. It is one of the most important bodies through which Centre-State financial relations are determined and put into effect. Although the Constitution provides for Central transfers to the states, it does not mention how and on what basis these transfers need to be made. In this regard, the finance commission becomes highly important and impactful. Thus, the precise and specific decisions relating to fiscal power-sharing is deliberated in this forum, which is appointed by the President (under Article 280) every five years.
The first Commission, established in 1951, laid down certain principles in its first report such as –
- The additional resources from the Centre should be transferred to the States in such a manner that they do not pose a burden on the Centre in looking after vital matters such as defence and economic development.
- Distribution of resources and grants-in-aid should be uniformly made between all the States without any bias.
- The distribution of resources should in turn result in lesser inequalities between the States.
- The most recent is the Fifteenth Finance Commission, set up under the chairmanship of Shri N.K. Singh.
As mentioned earlier, the Constitution of India consists of three lists under the Seventh Schedule – the Union List, the State List, and the Concurrent List. The subjects mentioned under each of the three lists come exclusively under the jurisdiction of the Centre (for union list), the States (for state list), and both Centre and State (for concurrent list).
The Constitution provides for the division of taxes and non-tax revenues under Articles 268-293. Although the Constitution provides for independent sources of revenue for States by allowing them to levy taxes on certain subjects under the State List, they are still heavily dependent on the Centre for a majority of their revenues and subsidies.
The 80th Constitutional Amendment of 2000 implemented the recommendations of the Tenth Finance Commission which called for a share of 29% of Central duties and taxes to the States. Non-tax revenues are divided amongst Centre and States with the former having “posts, telegraph, banking, broadcasting, railways, coinage currency, PSUs, escheat and lapse” and the latter having “Irrigation, forests, fisheries, PSUs (state),escheat and lapse” under them.
Besides sharing of tax and non-tax revenues, the Constitution provides for certain Grants-in-aid to the States from the Central resources. These are of two types –
ü Statutory Grants – Under Article 275, these are provided to the States that require “special assistance” from the Consolidated Fund of India. Specific grants can also be given for the development and upliftment of the Scheduled Tribes and the administration of the Scheduled Areas within a particular state.
ü Discretionary Grants – Under Article 282, these are given to the States on the advice and recommendation of the Planning Commission to fulfil the targets set forth by the states. However, they are largely under the discretion of the Union Government, who may or may not reject the giving away of these grants.
A CRITICAL ANALYSIS OF CENTRE-STATE FISCAL RELATIONS
The 73rd and 74thAmendment to the Constitution brought about major changes to the Indian system of federalism by introducing a “third-tier” government – The Local Government. The amendment provided for different sets of functions and sources of revenue for both the rural and urban local bodies. In accordance with this, each State had to set up a State Finance Commission to allocate fees and taxes for the local governments, and to suggest the distribution of the State’s taxes and grants.
The States criticized the Centre for the subsequent erosion of their authority and self-sufficiency but making them heavily dependent on the Centre for their financial resources. Grievances over Central taxes being more elastic whereas State taxes being less-elastic and narrow in scope further aggravated the problem. Another grey area between Centre-State relations is relating to indebtedness on the part of the States against Central loans.
Overall, the current fiscal set-up of the country represents the needs of the post-independence period. In this regard, it is well believed to be archaic in nature and requires major structural changes to suit the country’s evolving fiscal system. The Centre-State relationship needs refinement and reformation to better reflect the changing society and to prevent further issues and alienation of States from the Centre.
The complex nature of the Centre-State relations makes it difficult to evaluate and understand the underlying problems. Although efforts have been made in strengthening federalism in India, the bias towards the Centre creates vertical fiscal imbalances in the country. With recent developments ranging from the implementation of the Goods and Service Tax (GST), the Abrogation of Article 370, and the Covid-19 pandemic, the dynamics of Centre-State fiscal relations are bound to change and create further complexities. With India developing as a vibrant economy, and an important player in the international arena, the work of the Finance Commission, as well as the Constitutional mechanisms become even more important to fulfil the objectives of “fiscal federalism” that India is trying to achieve.
Author(s) Name: Tamanna Phukan (Symbiosis Law School, Hyderabad)
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