Fiscal Federalism: States Demand Fair Share and Autonomy from Centre
An editorial discusses the challenges states face in fiscal federalism, advocating for greater fiscal autonomy and a fair share in central transfers, especially concerning Centrally Sponsored Schemes and the GST regime.
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Quick Revision
States' share in central taxes (vertical devolution) was 41% for the 15th Finance Commission period (2021-26).
States' own tax revenue (SOTR) as a percentage of GSDP has declined from 7.1% in 2014-15 to 6.4% in 2022-23.
Centrally Sponsored Schemes (CSS) have increased, limiting states' fiscal autonomy.
The share of states in central transfers has declined from 35.1% in 2014-15 to 30.2% in 2022-23.
The share of grants in total transfers to states has increased, while tax devolution has decreased.
Key Dates
Key Numbers
Visual Insights
States' Fiscal Squeeze: Key Indicators
This dashboard highlights the key financial metrics illustrating the challenges faced by states in fiscal federalism, particularly concerning their share in central taxes and the impact of the GST regime.
- 14th FC Devolution Share
- 42%
- 15th FC Devolution Share
- 41%-1%
- Cesses & Surcharges
- Increasing Trend
- GST Compensation to States
- Ended June 2022
Percentage of the divisible pool of central taxes recommended for states by the 14th Finance Commission (2015-2020).
Percentage of the divisible pool recommended for states by the 15th Finance Commission (2020-2025). The reduction is partly attributed to the reorganization of Jammu & Kashmir into UTs.
The Centre's increasing reliance on cesses and surcharges, which are not part of the divisible pool, effectively reduces the states' share of central tax revenues.
The guaranteed compensation for revenue loss to states post-GST implementation concluded, leading to renewed demands for extension or alternative mechanisms.
Evolution of Fiscal Federalism in India: Key Milestones
This timeline traces the significant historical and policy developments that have shaped fiscal federalism in India, from its constitutional origins to recent reforms and challenges.
India's fiscal federalism has evolved from a strong unitary bias inherited from colonial rule to a more cooperative yet contentious system. Key constitutional bodies like the Finance Commission and reforms like GST have continuously reshaped the financial relationship between the Centre and states, often leading to debates over resource distribution and states' fiscal autonomy.
- 1935Government of India Act, 1935: Laid foundation for federal structure with strong unitary bias, influencing financial distribution.
- 1951First Finance Commission constituted (K.C. Neogy): Established the constitutional mechanism for Centre-State financial transfers.
- 2003Kelkar Task Force on Indirect Taxes proposes Goods and Services Tax (GST): Initiated the long journey towards a unified indirect tax regime.
- 2016Constitution (101st Amendment) Act: Paved the way for GST implementation, creating the GST Council (Article 279A).
- 2017GST implemented (July 1): Major indirect tax reform, centralizing some revenue streams and altering Centre-State financial dynamics.
- 202015th Finance Commission (2020-25) report submitted: Recommended 41% state share, new devolution criteria, and focus on fiscal consolidation.
- 2022GST Compensation to states ends (June): Led to states' demands for extension or alternative revenue support mechanisms.
- PresentStates demand fair share and autonomy: Ongoing debate on fiscal space, conditional grants (CSS), and untied funds.
Editorial Analysis
The author advocates for strengthening fiscal federalism by granting states more fiscal space and autonomy, reducing the conditionalities of central transfers, and ensuring a fair and transparent distribution of resources, especially in the context of the GST regime and Centrally Sponsored Schemes.
Main Arguments:
- States' fiscal space is shrinking due to declining own tax revenues and increasing reliance on central transfers, which often come with conditions.
- The increasing share of Centrally Sponsored Schemes (CSS) limits states' flexibility to allocate funds according to their specific needs and priorities, potentially distorting state-level planning.
- The Goods and Services Tax (GST) regime, while beneficial for market integration, has centralized significant revenue streams, making states more dependent on the Centre for revenue sharing.
- The 15th Finance Commission's recommendations, particularly regarding vertical and horizontal devolution, have been a point of contention, with states arguing for a larger and more equitable share.
- True fiscal federalism requires a balance where states have sufficient resources and autonomy to fulfill their constitutional responsibilities and address regional disparities effectively.
Conclusion
Policy Implications
Exam Angles
Constitutional provisions related to Centre-State financial relations (Articles 268-281)
Role and recommendations of the Finance Commission (vertical and horizontal devolution criteria)
Impact of GST on fiscal federalism and state revenues
Distinction between Centrally Sponsored Schemes (CSS) and Central Sector Schemes
Challenges to cooperative federalism and fiscal autonomy of states
View Detailed Summary
Summary
This editorial delves into the complex relationship between the Centre and states regarding financial resources, a concept known as fiscal federalism. What's happening is that states are feeling a squeeze on their fiscal space, meaning their ability to raise and spend money independently. The article highlights concerns raised by states regarding the 15th Finance Commission's recommendations, particularly the vertical devolution (share of central taxes to states) and horizontal devolution (distribution among states).
A major point of contention is the increasing number of Centrally Sponsored Schemes (CSS), which often come with strict guidelines, limiting states' flexibility in spending. While these schemes are meant to address national priorities, they can distort state priorities and reduce their fiscal autonomy. The Goods and Services Tax (GST) regime, while unifying the market, has also centralized some revenue streams, making states more dependent on central transfers.
The editorial argues that for true fiscal federalism, states need more untied funds and a greater say in how funds are allocated, allowing them to address their unique developmental needs effectively.
Background
Latest Developments
Practice Questions (MCQs)
1. Consider the following statements regarding the Finance Commission in India: 1. It is a quasi-judicial body constituted under Article 280 of the Constitution. 2. Vertical devolution refers to the distribution of central tax revenues between the Union and the States. 3. Horizontal devolution criteria primarily consider population and area, with income distance gaining increasing weight in recent commissions. Which of the statements given above is/are correct?
- A.1 and 2 only
- B.2 and 3 only
- C.1 and 3 only
- D.1, 2 and 3
Show Answer
Answer: D
Statement 1 is correct. The Finance Commission is indeed a quasi-judicial body constituted by the President under Article 280 of the Constitution every five years or earlier. Statement 2 is correct. Vertical devolution refers to the division of the divisible pool of central taxes between the Union government and the states. Statement 3 is correct. Horizontal devolution refers to the distribution of the states' share among individual states. Criteria like population, area, forest and ecology, income distance, and demographic performance are used, with income distance often having a significant weight to address inequalities.
2. In the context of fiscal federalism in India, which of the following statements is/are correct? 1. Centrally Sponsored Schemes (CSS) typically provide states with untied funds, enhancing their flexibility in spending. 2. The Goods and Services Tax (GST) regime has centralized some revenue streams, making states more dependent on central transfers. 3. The 15th Finance Commission introduced 'demographic performance' as a new criterion for horizontal devolution among states. Select the correct answer using the code given below:
- A.1 and 2 only
- B.2 and 3 only
- C.1 and 3 only
- D.1, 2 and 3
Show Answer
Answer: B
Statement 1 is incorrect. Centrally Sponsored Schemes (CSS) are schemes where the Centre provides financial assistance to states for specific programs, often with strict guidelines and conditionalities. This limits states' flexibility and reduces their fiscal autonomy, making the funds 'tied' rather than 'untied'. Statement 2 is correct. The GST regime, by subsuming various state and central indirect taxes, has centralized significant revenue streams, increasing states' dependence on the GST Council's decisions and central transfers. Statement 3 is correct. The 15th Finance Commission indeed introduced 'demographic performance' as a criterion for horizontal devolution, rewarding states that have performed well in controlling population growth.