The Constitution of India balances financial autonomy and structural unity through the distribution of legislative taxing powers under the Seventh Schedule, specifically separating the revenue domains of the Union and the States.
Seventh Schedule Distribution
- Union List (List I): Houses subjects of national importance. The Central Government holds exclusive legislative competence over specific items including Income Tax (excluding agricultural income – Entry 82), Customs Duties (Entry 83), Corporation Tax (Entry 85), and Central Excise Duties on tobacco and manufactured goods excluding alcohol and narcotics (Entry 84).
- State List (List II): Entrusts exclusive taxation rights to State Governments over localized matters. Key items include Land Revenue (Entry 45), Agricultural Income Tax (Entry 46), Duties of Excise on alcoholic liquors for human consumption (Entry 51), and Taxes on professions, trades, callings, and employments (Entry 60).
- Concurrent List (List III): Avoids overlapping taxation to prevent double taxation, holding no specific tax entries until the introduction of Article 246A via the 101st Constitutional Amendment Act, which granted concurrent powers to both Parliament and State Legislatures to legislate on the Goods and Services Tax (GST).
Constitutional Articles Governing Tax Revenue Distribution
Articles 268 to 281 in Part XII of the Constitution lay down the structural flow of tax distribution, specifying who levies, who collects, and who appropriates the financial resources.
| Constitutional Article | Tax Classification & Mechanism | Institutional Framework & Core Examples |
| Article 265 | Taxes not to be imposed save by authority of law. | Prohibits arbitrary extraction of revenue; requires legislative backing for all taxes. |
| Article 266 | Consolidated Funds and Public Accounts of India and States. | Defines the core accounts into which all revenues flow and from which expenditures are legally appropriated. |
| Article 268 | Levied by the Union but collected and appropriated by the States. | Stamp duties on bills of exchange, cheques, promissory notes, etc. These proceeds are retained by the respective states and do not form part of the Consolidated Fund of India. |
| Article 268A (Omitted) | Service tax levied by Union, collected and appropriated by the Union and States. | Inserted by the 88th Amendment Act 2003, but officially omitted by the 101st Amendment Act 2016 following the rollout of GST. |
| Article 269 | Levied and collected by the Union but assigned to the States. | Taxes on the inter-state sale/purchase of goods (Central Sales Tax) and goods consignment. These proceeds are assigned completely to the states. |
| Article 269A | Levy and collection of GST in the course of Inter-State trade or commerce. | Integrated GST (IGST) is collected by the Union and apportioned between the Union and States based on the recommendations of the GST Council. |
| Article 270 | Levied and collected by the Union and distributed between the Union and States. | Forms the “Divisible Pool” of central taxes. Includes all taxes under the Union List except Articles 268, 269, 269A, and central cesses or surcharges. |
| Article 271 | Surcharge on certain duties and taxes for purposes of the Union. | Empowers Parliament to levy surcharges and cesses for specific central targets. These proceeds flow exclusively to the Union and bypass the divisible pool. |
Key Surcharges and Cesses Excluded from Devolution
- Krishi Kalyan Cess: Levied to support agricultural initiatives.
- Health and Education Cess: A 4% surcharge added onto personal income tax and corporation tax to fund public infrastructure.
- Road and Infrastructure Cess: Imposed on petrol and diesel to finance national highway networks.
Constitutional Mechanisms for Resource Adjustments: Grants-in-Aid
Grants-in-aid act as the fiscal corrective mechanism to address vertical imbalances (the gap between central revenue collection and state expenditure duties) and horizontal imbalances (disparities among states due to varying developmental levels).
Statutory Grants (Article 275)
- Funding Source: Charged directly on the Consolidated Fund of India, making them non-votable by Parliament.
- Institutional Authority: Issued based on the formal recommendations of the Finance Commission.
- Targeting: Variable financial support tailored strictly to specific states in need of assistance, particularly utilized to augment the administration of Scheduled Areas and fund Scheduled Tribe development programs.
Discretionary Grants (Article 282)
- Funding Source: Provided out of the public revenue resources of either the Union or the States.
- Institutional Authority: Executed entirely under the discretionary power of the executive branch, completely independent of Finance Commission mandates.
- Targeting: Allocated for any recognized “public purpose,” historically serving as the legal vehicle for Central Sector and Centrally Sponsored Schemes.
Miscellaneous Constitutional Allocations
- Article 274: Requires prior recommendation of the President of India for any bill or amendment that varies taxes in which states are financially interested, or which alters the definition of “agricultural income” under income tax law.
Constitutional Statutory Pillars of Fiscal Devolution
The Finance Commission (Article 280)
The Finance Commission is a quasi-judicial body constituted by the President of India every five years (or earlier) to recommend the terms of tax sharing between the central and state tiers.
Core Functional Mandate (Article 281)
- Determination of the allocation of net proceeds of shareable taxes between the Union and the States (Vertical Devolution).
- Formulation of a performance-and-need-based mathematical formula to distribute the states’ share among individual states (Horizontal Devolution).
- Delineation of principles governing statutory grants under Article 275.
- Recommending structural measures to augment the Consolidated Fund of a State to assist local bodies (Panchayats and Municipalities) based on evaluations from State Finance Commissions.
Comparison of Evolution Criteria: 15th vs 16th Finance Commission
The criteria used to determine horizontal devolution strike a balance between financial equity and economic efficiency:
| Devolution Criteria | 15th Finance Commission Weight (%) | 16th Finance Commission Weight (%) |
| Income Distance | 45.0 | 42.5 |
| Population (2011 Census) | 15.0 | 17.5 |
| Area | 15.0 | 10.0 |
| Forest Cover / Forest & Ecology | 10.0 | 10.0 |
| Demographic Performance | 12.5 | 10.0 |
| Contribution to GDP | — | 10.0 |
| Tax and Fiscal Efforts | 2.5 | — |
| Total Allocation | 100% | 100% |
Key Structural Changes by the 16th Finance Commission (2026–2031)
- Vertical Devolution: Retained the vertical sharing ratio at 41% of the divisible pool, maintaining continuity with the 15th Finance Commission’s award.
- Introduction of Contribution to GDP: Replaced the “Tax and Fiscal Efforts” parameter with a new 10% weight for “Contribution to GDP” to financially reward economically productive and highly industrialized states.
- Demographic Performance Realignment: Redefined demographic performance to account for population growth trends between 1971 and 2011, shifting away from a metric solely focused on Total Fertility Rate (TFR).
- Rationalization of Grants: Consolidated the system by completely discontinuing revenue deficit grants, sector-specific grants, and state-specific grants, focusing instead on local body and disaster management allocations.
The Goods and Services Tax (GST) Council (Article 279A)
Created by the 101st Constitutional Amendment Act 2016, the GST Council serves as an institutional mechanism for cooperative federalism, regulating a single unified indirect tax regime.
Voting and Decision-Making Structure
- Central Representation: The Union Finance Minister (Chairperson) and the Union Minister of State in charge of Revenue/Finance hold one-third (33.33%) of the total voting power.
- State Representation: Finance or Taxation Ministers from all 28 states and 3 Union Territories with legislatures (Delhi, Puducherry, Jammu & Kashmir) hold two-thirds (66.67%) of the total voting power.
- Decision Threshold: Any resolution or decision within the council requires a mandatory three-fourths (75%) weighted majority vote of the members present and voting.
Borrowing Regimes and Constitutional Restrictions
Federal Borrowing Provisions (Articles 292 and 293)
- Union Borrowing Powers (Article 292): The executive power of the Central Government extends to raising loans both within the domestic market and from international sovereign or institutional lenders, secured against the Consolidated Fund of India, up to limits prescribed by Parliament.
- State Borrowing Powers (Article 293): State executives are constitutionally restricted to borrowing solely within the domestic borders of India, using the Consolidated Fund of the State as security.
- Central Consent Rule (Article 293[3]): A State Government cannot raise any fresh loan without the express consent of the Central Government if there remains any outstanding portion of a prior loan extended to the State by the Union, or for which the Union has extended a repayment guarantee.
Emergency Impact on Financial Relations (Article 360)
During a declared Financial Emergency, the normal constitutional distribution of financial powers undergoes a temporary shift toward centralization:
- The President of India is empowered to issue directions requiring all Money Bills or Financial Bills passed by individual State Legislatures to be reserved for Presidential consideration and assent.
- The Union executive can direct State Governments to reduce the salaries and allowances of all classes of public officials, including Judges of the State High Courts.