Fiscal federalism deals with division of revenue between the Centre and the States. The Government of India Act 1919 and 1935 formalized the tenet of fiscal federalism and revenue sharing between the Centre and the States, aimed at enhancing political, economic and administrative efficiency, and granting increased autonomy to the provinces of India.
Typically, federations face vertical and horizontal imbalances. A vertical imbalance arises because the tax systems are designed in a manner that yields much greater tax revenues to the Central government when compared to the State governments. The horizontal imbalances arise because of differing levels of attainment by the states due to differential growth rates and their developmental status in terms of the state of social or infrastructure capital.
After India achieved its Independence, the Indian Constitution prescribed for federal structure of government and defined fiscal relations between centre and states. It ensured distribution of powers through central, state and concurrent list which also divided the taxing and expenditure power between centre and states. The Central government has been given powers in respect of custom duties, excise duties, income tax, taxes on capital values, estate duty in respect of property other than agricultural land, terminal taxes on goods or railway passengers carried by railway, sea or air, taxes other than stamp duties on transactions in stock exchanges and futures markets.
The State governments have been given exclusive tax powers in respect of land revenue, taxes on agricultural income, duties in respect of succession to agricultural land, estate duty in respect of agricultural land, taxes on land and buildings, excise duties on goods containing alcoholic liquors for human consumption. The Constitutional Amendment Act, 1956 empowered states to impose sales tax under Central Sales Act 1956.
The Constitution also provided for distribution of net proceeds of taxes between centre and states and allocation between states based on recommendation of Finance Commission. Taxation power and devolution of its revenue between centre & states are governed by list of constitutional articles such as Article 268–271. This tax arrangement between centre and the states has been dynamic and has been amended from time to time as per requirements e.g 88th Constitutional Amendment Act 2003, introduced Service Tax to be collected and appropriated by centre and states (Article 268-A).
The Central government also established the Planning Commission which was a non-statutory body for socio-economic planning of states and devolution of revenues to states in form of discretionary aid. The devolution and transfer to states mainly comprised of states share in taxes, grants in aid and loans to states. However, after the economic reforms of 1991, the government became a facilitator rather than a provider of services. This era also witnessed rise of income inequalities among states which caused regional imbalances and state and central government schemes failed to ensure necessary services. Recently, the Central government initiated various economic measures for empowering the states financially.
Niti Aayog
A nation like India not only requires fiscal federalism to meet to need of the governments but also cooperative federalism to address some complex common problems. However the planning process remained centralized with inception of planning commission which proceeded with top down approach and one size fit all formula. Moreover the state did not have any direct say in policy planning by the Planning Commission. As a result the plans failed to address diverse regional issues in the country.
The NITI Aayog replaced the Planning Commission on 1 January, 2015 to inculcate the spirit of cooperative federalism in India through active involvements of all state governments and structured support initiatives and mechanisms with the states on a continuous basis, recognizing that strong states make a strong nation. One of its functions is to design strategic and long term policy and programme frameworks and initiatives, and monitor their progress and their efficacy. But the NITI Aayog is primarily a think tank with no power to have a say in budgets of state governments. The Planning Commission acted as an advisor to state governments on budgetary matters of state governments so that they could make economic transformation in their states.
NITI Aayog should be mandated to create an independent evaluation office which will monitor and evaluate the efficacy of the utilization of grants given to state governments. This office must also advise state governments on economic matters through various reports. It should not be involved in budget making of state governments.
Fourteenth Finance Commission (Ffc)
The FFC has increased the amount that the centre has to transfer to the states from the divisible pool of taxes by 10 percentage points, from 32 per cent to 42 per cent. Compared with the previous two Finance Commissions (FCs) that increased the share going to the states by 1 and 1.5 percentage points, respectively. Due to greater devolution, state governments would have greater resources at its disposal to undertake social and economic transformation in their states. The FFC also recommended grants to rural and urban local bodies, a performance grant and grants for disaster relief. The recommendations of the FFC have the potential to redefine Indian federalism in a long overdue and desirable manner.
Centrally Sponsored Schemes (Css)
The centrally sponsored schemes cover several areas of state subjects which are crucial for realizing national development goals. These schemes are implemented by state government based on in guidelines of Union Government. However a number of CSS often overlapped with each other and its rigidity and centralized tendency prevented it in addressing regional needs.
The Union Government has reduced CSS from 66 to 28 umbrella schemes. Reduction of schemes with increased devolution helps the state government to address the several areas effectively without being dependent on centre. The flexibility inculcated in these schemes allow state government to design them as per their requirements in order to improve their efficiency.
Goods And Service Tax (Gst)
GST came into effect from 1 July, 2017 through the One Hundred and First Constitutional Amendment Act, 2016. The Goods and Services tax is a uniform indirect tax levied on all goods and services produced in the country and all goods and services imported from abroad. GST will be a single uniform indirect tax which will treat India as one market. It will replace all Central and state indirect taxes like CENVAT, excise, customs, VAT, state excise, etc. The GST has resulted in a single price of a product across the country, lower working capital for companies and a more simplified tax system.
The Amendment also created the GST Council by inserting Article 279-A in the Constitution. The Council comprises of the union finance minister as chairman and state finance ministers as members. The Council shall make recommendations on matters relating to the GST. In the Council, the votes of the Central government will weightage of one-third of the total votes cast. Rest two-third weightage is given to the states. The Council with the cooperation of the centre and the states has resulted in cooperative federalism in the matter of indirect taxes.
Public Financial Management System (Pfms)
Public Financial Management System (PFMS) is a financial management platform for all plan schemes, a database of all recipient agencies, integration with core banking solution of banks handling plan funds, integration with state treasuries and efficient and effective tracking of fund flow to the lowest level of implementation for plan scheme of the Government.
Due to the monitoring of funds through PFMS, one can know the actual status of utilization of funds by the multiple implementing agencies of the central and the state governments. The ultimate purpose of implementing any Scheme is to ensure that the benefits much reach to the last mile.
Funds under the centrally sponsored schemes flow almost entirely to the state government treasuries and a substantial part of the funds under the central sector schemes are also spent in the states through various central government agencies. The improvements brought-out in the management of public funds through PFMS, will have a cascading beneficial impact on the management of state government public finances as well as efficient delivery of public services by the states. PFMS, therefore, reflects the true spirit of Cooperative Federalism with the Centre and the State Governments combining their efforts to improve public finance management for ultimate public good.
These new economic measures are well intended to transform fiscal relations between the centre and the states. But these measures are not perfect. GST needs improvement in terms of procedure, longer period of compensation to states in case of deficit of revenue, than the mandated period of five years