Intergovernmental Fiscal Transfers

Intergovernmental fiscal transfers are the mechanisms through which funds are allocated between the Union government and state governments. The Constitution of India, particularly Article 280, establishes the Finance Commission to recommend principles governing these transfers, addressing the mismatch between revenue-raising powers and expenditure responsibilities.

Key provisions include:

• •Vertical fiscal imbalance: Addressing the gap between the Union government's revenue and states' expenditure needs.
• •Horizontal fiscal imbalance: Addressing the differences in revenue and expenditure needs across states.
• •The Finance Commission: A constitutional body recommending principles for tax revenue distribution.
• •Article 280: Deals with the constitution, functions, and powers of the Finance Commission.
• •Tax devolution: Sharing of tax revenues collected by the Union government with the states.

In practice, the Finance Commission assesses the revenue needs of states and the Union, and recommends the proportion of Union taxes to be shared with states (tax devolution). It also recommends grants-in-aid to states based on specific needs or for specific purposes. These recommendations are then considered by the Union government for implementation.

Tax sharing involves devolving a portion of the tax revenue collected by the Union government to the states. Grants-in-aid are specific amounts of money given to states, often for specific purposes or to address specific needs. Tax sharing is formula-based, while grants-in-aid can be discretionary.

Challenges include:

• •Ensuring equitable distribution among states with varying needs and capacities.
• •Balancing the fiscal autonomy of states with the need for fiscal discipline.
• •Addressing concerns about the weightage given to different criteria by the Finance Commission.
• •Political considerations influencing the acceptance and implementation of the Finance Commission's recommendations.

Suggested reforms include:

• •Greater emphasis on performance-based incentives for states.
• •Improving the transparency and predictability of transfers.
• •Strengthening the capacity of state governments to manage their finances effectively.
• •Reviewing the criteria used by the Finance Commission to ensure fairness and equity.

Intergovernmental fiscal transfers are crucial for:

• •Ensuring balanced regional development by providing resources to states with lower revenue-generating capacity.
• •Enabling states to provide essential public services like health, education, and infrastructure.
• •Promoting cooperative federalism by fostering financial cooperation between the Union and the states.
• •Reducing disparities in living standards across different states.

Initially, transfers were largely based on population and revenue needs. Over time, criteria like fiscal discipline, infrastructure development, and environmental protection have gained importance. The 15th Finance Commission recommended significant changes in the criteria for tax devolution, reflecting a shift towards performance-based incentives.

Important articles include:

• •Article 268 (Duties levied by the Union but collected and appropriated by the States)
• •Article 269 (Taxes levied and collected by the Union but assigned to the States)
• •Article 270 (Taxes levied and collected by the Union and distributed between the Union and the States)
• •Article 275 (Grants from the Union to certain States)
• •Article 280 (Finance Commission)

A common misconception is that transfers are solely based on population. While population is a factor, other criteria like fiscal discipline, infrastructure, and special needs of states are also considered. Another misconception is that transfers are a form of charity; they are a constitutional mechanism to address fiscal imbalances.

India's system, with a constitutionally mandated Finance Commission, is unique. Many countries rely on negotiated agreements or administrative decisions for fiscal transfers. The degree of central control and the criteria used for transfers also vary significantly across countries.

Frequently asked aspects include:

• •Role and functions of the Finance Commission.
• •Criteria for tax devolution.
• •Challenges of fiscal federalism.
• •Impact of transfers on state finances.
• •Recent developments and reforms in the transfer mechanism.