Fiscal federalism in India

Published on 06 Jan 2025

Fiscal federalism in India

Fiscal federalism describes how the financial powers and responsibilities are divided between different levels of the government in a country. It involves how revenues are raised and shared by different tiers and how expenditure is made by them.

Agents of fiscal federalism in India

• Taxation power for centre and state: Constitution has partitioned the subjects based on the government responsible to levy and collect them.

• Example: Article 268 mentions subjects on which taxes are levied by the centre but are collected by the state government.

• Finance commission: Article 280 calls for creating a body which decides upon the distribution of revenue between centre and states and among different states.

• Example: The 15th Finance Commission called for vertical devolution of funds to be maintained at 41%.

• Grant in aid mechanism: The central government gives grants which supplements the resources of the state.

• Example: Finance Commission recommended central government provide revenue deficit grants worth 86000 crore to 14 states in 2022-23.

• GST Council: The body has representation from both centre and states with two thirds of the voting powers with the state.

Concerns associated with fiscal federalism in India

• Vertical fiscal imbalance: Arises when the revenue raising capacity of the central government exceeds its expenditure responsibilities, while the state government faces fiscal constraints.

• Example: The capital expenditure by states is around $10.5 trillion while that of the centre is $8.4 trillion indicating the increased expenditure for states.

• Introduction of GST: The new taxation regime has reduced the freedom of states to raise revenue from taxes and this affects their fiscal independence.

• Example: GST has replaced state taxes like VAT, Entry tax, Purchase tax, Advertisement tax etc.

• Central domination within the GST council: Centre has 33% voting powers and decisions can be passed only with 75% support, hence centre gets the veto power.

• Increase in cess and surcharge: These are not required to be shared with the states and hence creates fiscal imbalance between centre and state.

• Example: Between 2017-18 and 2022-23, cess and surcharge collected by the central government increased by 133%.

• Low financial autonomy for local bodies: Many of the local bodies have limited powers concerning taxation and they function through grants which are mostly of tied nature.

• Example: According to the recommendations of the Fifteenth Finance Commission (FC-XV), 60% of the grants are of tied nature.

• Centrally sponsored schemes: This imposes an obligation upon states to divert the expenses for such schemes which reduces their fiscal autonomy.

• Example: Expenditure under centrally sponsored schemes reduced by 9% in FY 2023 due to inability of states to meet the expense.

• Constitution of Finance Commission: There is no involvement of states in the formation of the finance commission.

Thus, distribution of finance must reduce this imbalance and grant more independence to states in exercising their funds. Proper payment of GST compensation must be made to balance the taxes forgone by the states. There is a need to rationalize the centrally sponsored schemes, reduce the dependence on cess and give more fiscal powers to local governments to improve the state of fiscal federalism in India.

Tags:
Polity

Keywords:
Federalism Fiscal federalism Finance Commission GST council

Syllabus:
General Studies Paper 2

Topics:
Indian Constitution