Indian fiscal federalism is structured to balance regional aspirations with national integrity. The Constitution of India provides a detailed schema for the distribution of financial resources and taxing powers between the Union and the States, primarily embedded in Part XII.
Constitutional Allocations and General Principles
- Article 246: Grants legislative competence for taxation. The Union Parliament has exclusive power to tax subjects in List I (Union List), while State Legislatures tax subjects in List II (State List). List III (Concurrent List) generally avoids tax entries to prevent double taxation, except through specific amendments like the Goods and Services Tax (GST).
- Article 265: Mandates that no tax shall be levied or collected except by authority of law, ensuring strict legislative oversight over executive tax collection.
- Residuary Powers: Under Article 248, the power to legislate on residuary taxes (taxes not explicitly mentioned in any list) vests exclusively with the Parliament.
Distribution of Revenues Between Union and States
The Constitution distinguishes between the power to levy a tax, the power to collect it, and the right to appropriate its proceeds. This design addresses the structural fiscal asymmetry where the Centre holds high-yield elastic tax bases while States bear expansive socio-economic development responsibilities.
Tax Distribution Categories (Post-101st Amendment Act)
| Constitutional Article | Tax Type / Description | Levied By | Collected By | Appropriation / Assignment |
|---|---|---|---|---|
| Article 268 | Stamp duties on bills of exchange, cheques, promissory notes, etc. | Union | States (Except Union Territories) | Proceeds belong entirely to the respective States where collected. |
| Article 269 | Taxes on the sale or purchase of goods in the course of inter-State trade or commerce (CST). | Union | Union | Assigned entirely to the States in accordance with principles formulated by Parliament. |
| Article 269A | Integrated Goods and Services Tax (IGST) on inter-state trade and imports. | Union | Union | Apportioned between the Union and the States based on recommendations of the GST Council. |
| Article 270 | Taxes levied and distributed between the Union and States (The Divisible Pool). Includes Income Tax, Corporation Tax, CGST. | Union | Union | Distributed between Union and States based on the criteria fixed by the Finance Commission. |
Non-Tax Revenue Sources
- Union Sources: Railways, Posts and Telegraphs, Banking, Currency and Coinage, Sovereign Mints, Public Sector Undertakings (PSUs) owned by the Centre, and Escheat (property lapsing to the state due to lack of an heir).
- State Sources: Forests, Fisheries, State PSUs, Irrigation works, Land Revenue, and Lotteries organized by the State.
Institutional Mechanisms for Cooperative Fiscal Governance
To prevent fiscal friction and harmonize macroeconomic policies, the Indian Constitution and statutory bodies provide structured institutional platforms.
The Finance Commission (Article 280)
The Finance Commission is a quasi-judicial body appointed by the President of India every five years (or earlier) to recommend the distribution of net tax proceeds.
- Core Mandate: Recommends the vertical devolution (share of taxes given to States from the Union pool) and horizontal devolution (allocation among the states based on equity and efficiency criteria).
- Article 275 (Grants-in-Aid): The Commission recommends statutory grants-in-aid of the revenues of specific States in need of assistance, charged directly on the Consolidated Fund of India.
The Goods and Services Tax (GST) Council (Article 279A)
Introduced via the 101st Constitutional Amendment Act, 2016, the GST Council is a joint forum of the Centre and the States, embodying structural cooperative federalism.
- Composition: Chaired by the Union Finance Minister; members include the Union Minister of State for Revenue and the Finance Ministers of all State Governments.
- Voting Mechanism: The Union holds one-third (1/3) of the total voting power, while all State Governments combined hold two-thirds (2/3) of the voting power. Every decision requires a majority of not less than three-fourths (3/4) of the weighted votes present and voting, effectively giving both the Centre and a coalition of States a veto power.
Grants-in-Aid and Financial Transfers
Apart from tax devolution, the Centre transfers funds to States to correct regional imbalances and fund specific welfare schemes.
Statutory vs. Discretionary Grants
| Feature | Statutory Grants (Article 275) | Discretionary Grants (Article 282) |
|---|---|---|
| Nature | Non-discretionary, based on constitutional entitlement. | Discretionary, used for public purposes. |
| Recommendation | Recommended by the Finance Commission. | Historically determined by the Planning Commission; now utilized for Central Sector and Centrally Sponsored Schemes (CSS). |
| Charge | Charged directly upon the Consolidated Fund of India. | Paid out of the allocable budgetary resources of the Union Ministries. |
Centrally Sponsored Schemes (CSS) and Central Sector Schemes
- Central Sector Schemes: Funded 100% by the Union government and implemented by Central agencies on subjects mostly in the Union List. Example: Crop Insurance Scheme (PM Fasal Bima Yojana).
- Centrally Sponsored Schemes (CSS): Co-funded by the Centre and the States according to fixed ratios (e.g., 60:40 for general states, 90:10 for North-Eastern and Himalayan States). Implementation lies entirely with the State Governments.
Borrowing Powers and Fiscal Discipline Framework
The Constitution regulates the debt-raising capacities of both tiers of government to ensure macroeconomic stability.
Constitutional Limits on Borrowing
- Article 292: Grants the Union executive the power to borrow money upon the security of the Consolidated Fund of India within limits fixed by Parliament. The Centre can borrow both domestically and externally.
- Article 293: Regulates borrowing by States. States can only borrow domestically upon the security of the Consolidated Fund of the State.
- Consent Requirement: Under Article 293(3), a State cannot raise any loan without the consent of the Centre if it has any outstanding part of a loan previously granted to it by the Centre or in respect of which the Centre has given a guarantee.
Fiscal Responsibility and Budget Management (FRBM) Framework
The FRBM Act, 2003 enacted by Parliament, along with corresponding State-level FRBM legislations, sets institutional targets for fiscal deficit and debt-to-GDP ratios. The Fourteenth and Fifteenth Finance Commissions linked additional borrowing space for States (beyond the standard 3% of GSDP) to specific performance milestones, such as implementation of power sector reforms and urban local body transformations.
Emergency Provisions and Impact on Fiscal Relations
During national crises, the normal distribution of financial arrangements can be altered to centralize financial command.
Article 360 (Financial Emergency)
When a Financial Emergency is proclaimed by the President of India, the fiscal autonomy of States is significantly curtailed:
- The Union executive can give directions to any State to observe specific canons of financial propriety.
- The President can issue directions for the reduction of salaries and allowances of all or any class of persons serving the State, including Judges of the High Courts.
- The President can require that all Money Bills or Financial Bills passed by State Legislatures be reserved for presidential consideration.
- Article 354: During a National Emergency (Article 352), the President can modify the provisions relating to the distribution of revenues between the Union and the States for a period not extending beyond the financial year in which the emergency ceases.