Reframing the Introduction
The Indian Constitution establishes a federal structure where power is divided between the Union (Centre) and the States. However, unlike classical federations such as the USA, India’s federalism is often described as “quasi-federal”, meaning the Centre possesses comparatively greater authority. This is particularly evident in financial relations, where the distribution of revenue-raising powers and responsibilities plays a crucial role in ensuring balanced development across the country. Efficient financial relations are essential for cooperative governance, economic stability, and equitable growth. Over the years, several constitutional provisions, Finance Commissions, and judicial interpretations have shaped and reshaped the nature of these financial relations.
Constitutional Basis for Financial Relations
The financial relations between the Centre and the States are mainly outlined under Part XII of the Constitution (Articles 264 to 300) and Seventh Schedule (Union, State, and Concurrent Lists).
Key Constitutional Articles:
- Article 268 to 281: Deal with the distribution of revenue.
- Article 275: Provides for grants-in-aid to States.
- Article 280: Establishes the Finance Commission.
- Article 293: Governs State borrowing.
These articles collectively determine the extent of financial autonomy and dependency of States on the Centre.
Distribution of Taxation Powers
Taxation powers in India are clearly divided to avoid overlap and ensure administrative efficiency:
| Authority | Taxes Levied |
|---|---|
| Union Government | Customs duties, Income Tax (except agricultural income), Company Tax, Excise duties, GST on inter-State supply |
| State Governments | State GST, Stamp duty (except those in Union List), Land Revenue, Excise on liquor, Tax on agricultural income |
| Both (Concurrent Reach) | GST (as per Article 246A and 101st Constitutional Amendment) |
The introduction of GST (Goods and Services Tax) in 2017 was one of the most significant reforms that restructured Centre-State fiscal interactions. A GST Council was established to promote cooperative federalism and ensure collective decision-making.
Distribution of Revenues
The Constitution provides three major mechanisms for revenue distribution:
1. Tax Sharing
Under Article 270, taxes collected by the Centre are shared with States based on recommendations of the Finance Commission. This ensures that States receive a proportionate share of national revenue.
2. Grants-in-Aid
Article 275 authorizes the Centre to provide financial assistance to States requiring additional support, especially weaker or special category States.
3. Centrally Sponsored Schemes (CSS)
Programs like MNREGA, PMAY, and health missions are partially funded by the Centre but implemented by States. While useful for development, they often reduce the fiscal autonomy of States.
Role of the Finance Commission
The Finance Commission (FC) is a constitutional body formed every five years to recommend:
- Percentage of divisible tax pool to be shared with States,
- Grants-in-aid,
- Principles for revenue distribution.
For example, the 15th Finance Commission recommended that 41% of Central taxes be devolved to States.
The Finance Commission plays a crucial balancing role by reducing regional disparities and promoting fiscal federalism.
Centre-State Financial Tensions
Despite constitutional clarity, several issues create friction:
1. Vertical Imbalance
The Centre has greater revenue-generating powers, while States bear most development expenditure responsibilities. This creates dependency.
2. Horizontal Imbalance
Different States have different economic capacities. Richer States revenue-wise often feel they subsidize poorer ones.
3. Conditional Grants and CSS
States sometimes argue that centrally sponsored schemes interfere with their autonomy and create “one-size-fits-all” policies.
4. GST Compensation Issue
Several States have expressed concern over delays and formula disputes regarding GST compensation, particularly after the COVID-19 pandemic.
Cooperative Federalism: A Modern Approach
To strengthen Centre-State fiscal relations, the idea of cooperative federalism has gained prominence. Institutions like:
- NITI Aayog, replacing the Planning Commission, focuses on policy cooperation rather than centralized planning.
- GST Council, where both Centre and States are represented equally, encourages negotiation and consensus-building.
This approach shifts the financial relationship from hierarchical to collaborative.
Judicial Perspective
Indian courts have affirmed the federal nature of the Constitution while recognizing the Centre’s coordinating role.
In State of West Bengal vs Union of India (1963), the Supreme Court held that the Union is not a mere league of States, and Parliament holds authority to legislate in national interest.
Courts have thus supported strong central guidance while still protecting State autonomy under the Constitution.
Recent Developments and Suggestions for Reform
To improve financial relations, experts propose:
- Greater decentralization in tax decision-making.
- Increased share of States in divisible tax pool.
- Transparent review of centrally sponsored schemes.
- Strengthening State capacities to raise local revenue (e.g., through property and municipal taxes).
Creating a more balanced fiscal environment is key to ensuring inclusive economic growth.
Mnemonic to Remember Key Elements
“TAX-GST-GRANT-FC”
T – Taxation Powers (Union vs State division)
A – Allocation of Revenues (Tax sharing & grants-in-aid)
X – Execution via CSS (Centrally Sponsored Schemes)
G – GST Council (Cooperative decision-making)
S – States’ Fiscal Needs (Vertical & horizontal imbalances)
T – Transfers recommended by Finance Commission
FC – Finance Commission (core balancing authority)
This helps recall essential aspects of Centre-State Financial Relations clearly.
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Deepen your understanding of Centre–State Financial Relations in India with a well-structured explanation available on Lawgnan.in. Learn how the Constitution distributes taxation powers, revenue sharing, and grants-in-aid to maintain fiscal balance across States. Explore the significance of GST, the role of the Finance Commission, and ongoing challenges like vertical and horizontal imbalances. Whether you are a law student, UPSC aspirant, or academic researcher, this comprehensive guide will help you grasp the evolving nature of fiscal federalism in India. Visit Lawgnan today to stay updated with current legal developments and strengthen your constitutional law knowledge!
