UNIT 17 FISCAL FEDERALISM IN INDIA

Structure
17.0 Objectives
17.1 Introduction
17.2 Principles of Federal Finance
17.2.1 Expenditure Assignment
17.2.2 Tax Assignment
17.2.3 Expenditure Assignments should Match
17.2.4 Revenue Sharing

17.3 Constitutional Provisions in India

17.3.1 Taxing Powers
17.3.2 Grants-in-Aid
17.3.3 Borrowings
17.3.4 Constitutional Mandate for Local Governments

17.4 Finance Commission

17.5 Recommendations of Thirteenth Finance Commission (THFC)
17.5.1 Critique of Recommendations of THFC
17.5.2 Recommendations and Local Governments

17.6 Challenges Posed to Fiscal Federalism

17.6.1 Role of Planning Commission
17.6.2 Trend towards Decentralisation
17.6.3 Inter-State Disparity

17.7 Let Us Sum Up

17.8 Exercises
17.9 Key Words
17.10 Some Useful Books
17.11 Answers or Hints to Check Your Progress Exercises

17.0 OBJECTIVES
This unit is concerned with Union-States financial relations. While going through
this unit, you will be able to:
 spell out the principles governing fiscal federalism;
 state the provisions enshrined in Indian Constitution relating to division of
financial powers between Union and States;
 appreciate the role of Finance Commission which constitutes a pillar of India’s
federal structure;
 appraise the role of Finance Commission versus Planning Commission;
 critically examine the various recommendations of 13th Finance Commission;
and
84
 evaluate the dimension and nature of issues involved in contemporary fiscal Fiscal Federalism
in India
federalism situation prevailing in the country.

17.1 INTRODUCTION
The framers of the Indian constitution wanted to build a strong united India. India
has adopted federalism to actualise and uphold the values of national unity, cultural
diversity, democracy, regional autonomy and rapid socio-economic transformation
through collective efforts. Any viable and durable federal polity must have its
counterpart in a system of efficient and equitable federal fiscal arrangement. The
diverse political, economic and juridical aspects of federal fiscal relations have
been discussed at length in the Commission on Centre-State Relations chaired
by Justice R.S. Sarkaria which reported in 1988. The Sarkaria Report observed
that from the functional stand-point, such a Constitution is not a static format, but
a dynamic process. The very dynamism of the system with all its checks and
balances brings in its wake problems and conflicts in the working of Union-State
relations.
The country is passing through major economic and political changes and, as a
reaction to over-centralisation in the past decades, the States have been asking for
greater freedom in the exercise of economic powers. Besides, the current policy
of decentralising economic decision making through liberalisation can aggravate
regional disparities and here the Centre has an important role to play. At the same
time, the less developed States will have to make corrections in their policies to
attract investment, otherwise disparities are going to be more.
In the light of this background, it is desirable first to know the constitutional
provisions and the role of Finance Commission and Planning Commission in this
regard. Let us begin with discussing the principles of Federal Finance.

17.2 PRINCIPLES OF FEDERAL FINANCE

Economic analysis with several layers of government has a long and distinguished
tradition in public finance. One of the most significant issues addressed in the
literature is that of proper devolution of tax/expenditure authority between different
levels of government. Federal fiscal arrangements are a necessary requirement of
decentralised government administration, particularly in a large country. At least
five, generally interrelated parameters define these arrangements:
i) Expenditure responsibilities
ii) Tax assignments
iii) Fiscal imbalances, if any
iv) Availability of financing alternatives
v) Institutional parameters.
Economic Principles for Designing a Good Federal Fiscal Structure: The
major parameters of an intergovernmental fiscal structure can affect the efficiency
of allocation of resources in an economy as well as other determinants of its
performance. Nowhere are federal fiscal structures designed from scratch (or
denovo), and economic considerations are not the only factors in their design.
Nevertheless, certain economic principles have been developed that can help
85
Monetary and Fiscal guide the reform of inter-governmental fiscal structure in any federal country,
Policies in India
provided its policy makers are concerned about the efficiency of resource
allocation and the performance of the economy. Some of these economic principles
are:

17.2.1 Expenditure Assignments

Expenditure assignments to different levels of government should be guided by at
least three economic principles. First, public services that benefit everyone (for
example, defence) and whose supply benefits from economies of scale (for example,
railways) should be provided by the central government. Second, public services
whose benefits are localised (for example, law and order) and for which different
people can have different preferences (for example, local roads) should be provided
by local governments. Third, public services whose benefits spill over to jurisdictions
other than those where they are actually provided (for example, public education
and public health) either should be provided centrally or should be subsidised by
the central government, depending on the estaimated value of the spill-over benefit.

17.2.2 Tax Assignments

Tax assignments to different levels of government could be guided by at least three
basic principles. First, taxes that are levied on: (a) relatively mobile factors of
production (for example, labour and capital), (b) at progressive rates (for example,
personal incomes), (c) cyclically sensitive tax bases (for example, personal
incomes and corporates profits), and (d) tax bases that are unevenly distributed
among jurisdictions (for example, natural resources) should all be assigned to the
central government. Second, taxes that are levied on immobile tax bases (for
example, land and property), and whose burden is not exportable to other
jurisdictions, should be assigned to local governments. (Neither taxes on the
consumption of goods and services, nor the corporate income tax, meet this
criterion). Third, large revenue yielding taxes that are inherently buoyant (for
example, personal income tax, enterprise profits tax, broad-based consumption
tax) can be assigned to the central government.

17.2.3 Expenditure Assignments should Match Tax

Assignments
In order to avoid large fiscal imbalances, expenditure assignments should match
the tax assignments at the corresponding levels. If they are unmatched, and lower
level governments are likely to face chronic fiscal deficits, ‘piggybacking’ of the
more elastic taxes of central governments (for example, of income taxes and/or
value-added tax), or of overlapping assigned taxes, should be allowed. If, despite
this strategy, fiscal imbalances continue for lower levels of government, alternative
financing methods may have to be considered.

17.2.4 Revenue Sharing

Revenue sharing should relate to any central government tax that (a) is progressive
and/or has a large built-in elasticity (for example, personal income tax or enterprise
income tax), and (b) is less distortionary and is a large revenue source (for
example, value-added tax or excise duties). No economic principles exist that
can help decide the exact proportions of the revenues of these taxes to be
transferred to the revenue sharing pool. Whatever the size of that pool, its
distribution among different lower level governments, can be guided by either the
86
‘needs’ principle or the ‘derivation’ principle. Tax effort made by the lower Fiscal Federalism
in India
level government could be added as yet another factor in designing the revenue
distribution formula. ‘Fiscal capacity’ and ‘fiscal needs’ of each jurisdiction
must be estimated with a clear, quantifiable, and transparent formula, as far
as possible.
The foregoing principles are primarily derived from economic considerations.
However, federal fiscal relations in no country of the world are based upon
economic considerations alone. It is, therefore, quite reasonable to expect
that historical, political, social and other noneconomic considerations will
continue to play an important role in the design of the federal fiscal structure
of the country. Federal fiscal relations in every country of the world will continue
to remain prisoners of history, traditions, institutions and politics. What can
be expected, at best, is only an incremental change from the present reality
rather than a very profound and fundamental change. Whatever the extent
and form of change, one hopes that it will make the structure transparent,
stable and predictable.

17.3 CONSTITUTIONAL PROVISIONS IN INDIA

The Constitution describes India as a Union of States. There are twenty eight
States and seven Union Territories making up the Indian Union. According to
census of 2011, the total area is 3,280 thousand square kilometers and the total
population is 120 crore. The Union Territories are under the administrative
responsibility of the Union Government (also referred to as Government of India
or Central Government). There are also local authorities (comprising municipalities,
municipal corporations, ZillaParishads, Village Panchayats, etc.); these are however
created under statute, and are under the administrative supervision of State
Governments.
Financial relations between the Union and State Governments are governed by
Constitutional provisions. There are three lists in the Constitution: List I mentions
97 categories of functions to be administered by the Union Government; these in
the main, include defence, foreign affairs, banking, currency and coinage, etc.
There are 66 categories of functions in List II to be administered by State
Governments; these include in the main, public order police local government,
public health, education, sanitation, agriculture, forests etc. List III is the Concurrent
list; it enumerates 47 categories of functions, including social and economic planning.
Residuary power is reserved for the Union. The Constitution describes separately
the sources of resources (tax and non-tax revenues and borrowed funds) for
Union and State Governments needed for discharging the administrative
responsibilities entrusted to each.
The basic point of financial relations is the division of tax-sources between the
Centre and the States. There should be no overlapping of tax jurisdiction, otherwise
it will cause confusion and conflict. The distribution of taxes in India is more logical
and thorough than in other federations. The Concurrent list, does not include
any sources of taxation. There is thus, an attempt to avoid all over-lapping.

17.3.1 Taxing Powers

Article 268 to 281 of the Indian Constitution deal with the distribution of revenue
between the Union and the States. In the Seventh Schedule items 82 to 92(a) in
the Union List and items 45 to 63 in the State List refer to sources of taxation. 87
Monetary and Fiscal As regards the division of taxing power, taxes that have an inter-state base are
Policies in India
under the legislative jurisdiction of the Union, while those having a local base came
under the jurisdiction of the States. The Union List contains 12 items of taxation.
Though they are all in the Union List, it does not mean that the revenues
from these accrue to the Union.
The Constitution (Eightieth Amendment) Act, 2000 has altered the pattern of
sharing of Central taxes between the Centre and the States in a fundamental
way. Prior to this amendment, Taxes on Income other than agriculture income and
Union duties of excise were shared with States under Articles 270 and 272
respectively. The Eightieth Amendment Act has substituted a new article for Article
270 and omitted the old Article 272. The new Article 270 provides as under:
“270(1) All taxes and duties referred to in the Union List, except the duties
and taxes referred to in Articles 268 and 269, respectively, surcharge on taxes and
duties referred to in Article 271 and any cess levied for specific purposes under
any law made by Parliament shall be levied and collected by the Government of
India and shall be distributed between the Union and the States.”
The Finance Commission is now required to recommend such per centage of
taxes or duties referred to in the new Article 270 that may be assigned to the
States and also recommend the manner in which these may be distributed among
the States. The main changes brought about by this amendment are as follows:
a) All Central taxes and duties, except those referred in Articles 268 and 269
respectively and surcharges and cesses, are to be shared between the Centre
and the States.
b) Only States in which these taxes and duties are ‘leviable in that year’ are
entitled to get a share in these taxes and duties.
c) A per centage of “net proceeds” of these taxes and duties as may be prescribed
by the President by order after considering the recommendations of the
Finance Commission is to be shared by States.
d) The per centage of “net proceeds” of these taxes and duties which is assigned
to the States in any financial year shall not form part of the Consolidated
Fund of India.
There are 19 items (as against 12 in the Union List) of which the most important
are land revenue, duties of excise on alcoholic liquors and narcotic drugs, general
sales tax and sales tax on motor spirit, stamps and registration, taxes on motor
vehicles, entertainment taxes and electricity duties. Every State levies these taxes
by law and collects and appropriate them. There is no complication about
States’ taxes. There is no tax item in the Concurrent list, hence no question
of common source of taxation. Article 274 of the Constitution protects the
interest of the States. The purpose of this Article is to safeguard the financial
interests of the States and prevent any possible inroads by the Centre into the
revenue preserves of the States, by making it obligatory for the Union Government
to take consent of the States through the President.

17.3.2 Grants-in-Aid
However, the Constitution expected that the Union Government would be left with
surplus of funds in relation to the duties it had to discharge and the States would
88 be deficient of resources in relation to their responsibilities. Hence, provisions
were made for supplementing the resources of State Governments. Under Article Fiscal Federalism
in India
275(1) of the Constitution, such sums as Parliament may by law provide shall be
given by the Union Government as grants-in-aid of the revenues of such States as
Parliament may determine to be in need of assistance, and different sums may be
fixed for different States. Further, such capital and recurring sums are to be paid
as grants-in-aid by the Union Government as may be necessary to enable a State
to meet the costs of such schemes of development as may be undertaken by the
State with the approval of the Government of India for the purpose of promoting
the welfare of the Scheduled Tribes in that State or raising the level of administration
of the Scheduled Areas therein to that of the administration of the rest of the areas
of that State. The actual amount of grants-in-aid payable each year are to be fixed
by the Government after considering the recommendations of a Finance
Commission. Federalism is not only a unifying but also a levelling up force.
Federal grants-in-aid to the constituent units have been necessary and this exists
in all federations. The simple reason behind this is that no system of distribution
of financial sources between the federation and the units can possibly meet the
needs of national development and social services which are usually the responsibility
of the units. By this device financially weaker States can be assisted in bettering
their economic conditions.The Constitution also allows the Union and State
Governments to make grants for any public purpose (Article 282). Article 282
has been kept outside the purview of the Finance Commission. Presumably, it was
meant to be used only in an emergency and not for the purpose of making any
regular financial assistance.

17.3.3 Borrowings
Article 292 of the Constitution empowers the Government of India to borrow
upon the security of the Consolidated Fund of India, i.e., the resources of the
Union, subject only to such limitations as Parliament by law may impose. The
Government of India can borrow internally as well as externally. States too are
empowered to borrow under Article 293. According to this Article, a State
cannot borrow outside India. The borrowing powers of the States are limited.
Furthermore, if a State is indebted to the Union (as every State is now), it may
not resort to further borrowing without the prior consent of the Central Government.
However, the State Governments do not regard this provision as putting them
unduly in the grip of the Union. It does not appear that the working of this Article
has been detrimental to the interest of the State.
The scheme of distribution of resources and of functions just described makes the
State Governments inevitably dependent upon the Central financial transfers,
for which the balancing devices have already been provided. The Constitutional
provisions have avoided rigidity in these balancing devices by leaving undefined
the exact quantum of devolution and its distribution among the States. Basically,
the working of Centre-State financial relations can be seen from the overall
result of financial operations on State finances. The relationship can also be
seen in terms of various elements of fiscal federalism such as sharing of taxes,
statutory and discretionary grants-in-aid, Central loans to States, performance
under Article 269 and so on.

17.3.4 Constitutional Mandates for Local Governments

Of late, there is a swing towards fiscal federalism that promotes democratic
decentralisation, which ideally should allow for an optimum equilibrium to be
reached through effective citizen’s engagement in expressing their preferences and 89
Monetary and Fiscal local government’s efficiency in meeting public demands. From a minuscule number
Policies in India
of 4,841 Lok Sabha, Rajya Sabha and state assembly members representing
the country, following the 73rd/74th Constitutional Amendments (CAs), India has
today 2.5 lakh local governments, comprising over three million elected
representatives which make the Indian federation the largest democratic country
with the biggest representative base in the world. The 73rd Constitutional
Amendment designs a six layered federal polity starting from (i) gram sabha,
through the (ii) gram panchayat, (iii) block and (iv) districtpanchayats (v) to
the state and (vi) the union which is the apex tier. The 74th Amendment
incorporates the urban local bodies (ULBs) into this federal structure. India is,
thus, a multi-level federalism which can be broadly categorised as a functional
co-operative federalism.
Articles 243I and 243Y of the Constitution spell out the tasks of the State Finance
Commission (SFC). They are to review the financial position of local governments
(LGs). The tasks are strictly patterned on the Union Finance Commission (UFC)
as provided for in the Article 280 of the Constitution. Following the 73rd/74th
Amendments, two sub-clauses were added to Article 280(3) which require the
Union Finance Commission (UFC) to recommend measures needed to augment
the consolidated fund of a state to supplement the resources of the Panchayat Raj
Institutions (PRIs) and ULBs in the state “on the basis of the recommendations
made by the Finance Commission of the State”. Each of the State governments
was required to pass legislation appointing PRIs and urban local bodies. It was
stipulated that election to these local bodies should be held within the stipulated
period. A separate list of 29 functions for rural local bodies and 18 items for urban
local bodies were placed in schedules and are assigned to local governments to
implement concurrently with the states. The sources of finance were also identified
for the local bodies. Each State government was required to appoint a State
Finance Commission to recommend tax devolution and grants to the local
governments.
Federalism in India is characterised by constitutional demarcation of revenue and
expenditure powers among the three levels of government. The institutional structure
of multilevel provision of public services is shown in Table 17.1. In addition to
Finance Commission, the Planning Commission also gives assistance to the
States based on a formula determined by the National Development Council and
different central ministries give specific purpose transfers to States. Below the
States, there are over a quarter million local governments. Of this about 3000
are in urban areas and the remaining in rural areas. Rural local governments again
are at three levels – district, Taluk (block) and village levels. The urban local
governments consist of municipal corporations in large cities, municipalities in
smaller cities and towns and in notified area committees in smaller towns. Each
of the State governments has devolved powers to levy certain taxes and fees to
village panchayats and urban local bodies. The States have also instituted a system
of sharing of States’ revenues and giving grants to urban and rural local bodies.
In addition, a number of Central sector and centrally sponsored schemes are
implemented by the local governments and the funds earmarked for the purpose
are passed on to them from the State governments for implementation.

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 Table 17.1: Organisation of multilevel fiscal system in India. Fiscal Federalism
in India

Central Government

UnionTerritories directly
controlled by the Centre State Government

Rural Local
Urban Local Government
Government

District Panchayat

Block Panchayat

Village Panchayat

Check Your Progress 1

1) Explain the principles of federal finance.
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2) What are the constitutional provisions relating to Centre-State financial relations.
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3) Explain the multilevel Fiscal System in India.
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Monetary and Fiscal
Policies in India 17.4 FINANCE COMMISSION
The per centages of tax receipts to be given to the State Governments and the
basis of their allocating among States are not specified in the Constitution. All
these were left to be decided by a Finance Commission.
The Constitution (Article 280) provides for the appointment of a Finance
Commission at the expiry of every fifth year or at such earlier time as the President
considers necessary, to make recommendations to the President as to: (a) the
distribution between the Union and States of the net proceeds of taxes which are
to be, or may be divided between them (under Chapter I of Part XII of the
Constitution) and the allocation between the States of the respective shares of
such proceeds; (b) the principles which should govern the grants-in-aid of the
revenues of the States out of the Consolidated Fund of India, and (c) any other
matter referred to the Commission by the President in the interests of sound
finance.
Thus, in terms of the Constitutional provision, a duly appointed Finance
Commission is entrusted with the task of determining the amounts to be transferred
to State Governments and of evolving principles for the distribution of such
recommended amounts among State Governments. The provision for the
appointment of an independent body for such purposes is a unique feature of
the Indian Constitution. It is meant to provide a measure of assurance to State
Governments that the entire problem of financial relationship between the Union
Government and them would be conducted on the basis of a periodical review
and the principles suggested by such an independent body. The element of
discretion or arbitrariness in giving financial assistance was meant to be
kept under check as a result of this provision.
The Constitution authorises the Finance Commission to determine their procedure.
The Finance Commission (Miscellaneous Provisions) Act, 1951 has conferred
on the Commission all the powers of a Civil Court under the Code of Civil
Procedure, 1908. In terms of the 1951 Act, the Commission is to be headed by
a person selected from those who have had experience in public affairs, and the
four other members are to be selected from among persons who: (a) are or have
been, or are qualified to be appointed as judges of the High Court; or (b) have
special knowledge of the finances and accounts of the Government; or (c) have
had wide experience in financial matters and in administration; or (d) have special
knowledge of economics. Every member of the Commission is to hold office for
such period as may be provided for in the Order of the President appointing him
but shall be eligible for reappointment.
The First Finance Commission was appointed in November 1951 submitted its
report in December 1952 and thirteen Finance Commissions have reported so far.
The following Table 17.2 presents details regarding years of establishment and
reporting of various Finance Commissions.

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 Table 17.2: Chronology of Finance Commission. Fiscal Federalism
in India
Five-year Plan Finance Year of Year of Name of
Period Commission Establishment Reporting Chairman
and Period of
Award
I 1951-56 First: November, December Shri.K.C.Neogi
1952-57 1951 1952
1956-61 Second: June, 1956 September Shri K.Santhanam
II
1957-62 1957
III 1961-66 Third: December, December Shri. AK.Chanda
1962-66 1960 1961
Annual Fourth: May, 1964 August, Justice
Plan, 1966-69 1965 P.V.Rajamannar
1966-69
Fifth: February, 1968 July, 1969 Shri. Mahavir
IV 1969-74 1969-74 Tyagi
Sixth: June, 1972 October, Shri K.
V
1974-79 1974-79 1973 Brahmananda
Reddi
VI Annual
Plan: Seventh: October,
June, 1977 Justice J.M.Shelat
1979-80 1979-84 1978
1980-85
VII 1985-90 June, 1982
Annual Eighth: First Report for Shri Y.B. Chavan
April, 1984
Plan: 1984-89 1989-90
1989-90
Annual Ninth: June, 1987 July, 1988 Shri N.K.P. Salve
Plan: 1990-95
1990-92 (Second December,
VIII
Report) 1989
1992-97 Tenth: June, 1992 December, Shri K.C. Pant
1995-2000 1994
1997-2002 Eleventh: July, 1998 June, 2000 Dr. A.M. Khusro
IX 2000-2005
2002-2007 Twelfth: November, November, Dr. C.Rangarajan
X 2005-2010 2002 2004

2007-12 Thirteenth November, December, Dr. Vijay Kelkar

XI 2011-2015 2007 2009

Each Commission has taken about one to one and a half years to submit its final
report. The Finance Commission, performs a constitutional function of
recommending the distribution of the “divisible pool” of Union taxes between
the Central and state governments. The challenge is to divide fairly and efficiently.
The former requires an impartial assessment of the needs of a state, while the
latter ensures that the commission does not end up perversely rewarding
backwardness. Efficiency also requires rewarding fiscal prudence. Thus the
share is not purely on the basis of tax collection, nor on state GDP, nor on
population. It is a judicious mix of all these factors and more.
93
Monetary and Fiscal
Policies in India 17.5 RECOMMENDATIONS OF THIRTEENTH
FINANCE COMMISSION (THFC)
The UFC’s task is defined by its terms of reference (TOR), which have been
expanding in recent times. Although the primary function of the UFC as envisaged
in the Constitution of India is to correct vertical and horizontal imbalances,
ever-broadening TOR have required it to look into, among other things, the critical
issues of macro-economic stability and fiscal restructuring by both the centre and
the states. The Thirteenth Finance Commission (THFC), 2010 to 2015, had larger
than usual TOR, which required it, apart from carrying out its primary task of
resource sharing, to suggest measures for improving the output and outcome of
government expenditure; to look into means of tackling climate change and
environmental sustainability; and to assess the implications of the proposed goods
and services tax (GST) on the finances of the centre and the states. The noticeable
features of the THFC recommendations areas are follows:
1) Enhancing the vertical share of tax devolution from 30.5 per cent to 32 per
cent.
2) A design for the GST and a compensation package linked to adherence to
the proposed design.
3) A revised road map for fiscal consolidation and ensuring compliance to it by
linking it to transfers.
4) Devolution of a specified share of central taxes to local bodies as grants.
5) A larger number of specific-purpose grants to address the issues defined in
the TOR such as climate change, sustainable development, and improving the
output and outcome of government expenditure.
One of the most significant recommendations is that on the sharing of resources
from the divisible pool of taxes so that local bodies also benefit from the buoyancy
of central revenues.
The following are some of the key recommendations of the Thirteenth Finance
Commission (Also see Table 17.3 and 17.4).
 The share of States in net proceeds of shareable Central taxes shall be 32
per cent every year for the period of the award.
 Revenue accruing to a State is to be protected to the levels that would have
accrued to it had service tax been a part of the shareable Central taxes, if
the 88th Amendment to Constitution is notified and followed up by a legislation
enabling States to levy service tax.
 Centre is to review the levy of cesses and surcharges with a view to reducing
their share in its gross tax revenue.
 The indicative ceiling on overall transfers to States on revenue account may
be set at 39.5 per cent of gross revenue receipts of the Centre.
 The Medium Term Fiscal Plan (MTFP) should be a statement of commitment
rather than intent.

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 Table 17.3: Total transfers to States as per Thirteenth Finance Fiscal Federalism
in India
Commission (2010-15).
(Rs. Crores)
I. Non-Special Share in Central Total Grants- Total
Category Taxes and Duties in-aid Transfers
1. Andhra Pradesh 1,00,616.0 13,532.3 1,14,148.3
2. Bihar 1,58,341.2 14,602.8 1,72,944.1
3. Chhattisgarh 35,825.2 6,175.5 42,999.7
4. Goa 3,857.8 516.2 4,374.0
5. Gujarat 44,107.1 9,682.9 53,789.9
6. Haryana 15,199.5 4,270.8 19,470.3
7. Jharkhand 40,640.3 7,238.4 47,878.6
8. Karnataka 62,774.9 11,601.4 74,376.3
9. Kerala 33,954.3 6,371.5 40,325.8
10. Madhya Pradesh 1,03,268.9 13,324.5 1,16,593.4
11. Maharashtra 75,406.9 16,302.8 91,709.8
12. Orissa 69,316.1 9,658.8 78,974.9
13. Punjab 20,146.4 5,540.3 25,686.6
14. Rajasthan 84,892.2 12,949.8 97,842.0
15. Tamil Nadu 72,070.4 11,366.9 83,437.3
16. Uttar Pradesh 2,85,397.1 26,742.9 3,12,140.0
17. West Bengal 1,05,358.6 12,638.7 1,17,997.2
II. Special Category
1. Arunachal Pradesh 4,755.6 4,348.2 9,103.8
2. Assam 52,620.6 5,212.1 57,832.7
3. Himachal Pradesh 11,327.3 10,364.4 21,691.6
4. Jammu and Kashmir 20,182.7 20,255.9 40,438.7
5. Manipur 6,541.2 7,026.3 13,567.5
6. Meghalaya 5,918.5 3,923.9 9,842.4
7. Mizoram 3,901.3 4,904.0 8,805.3
8. Nagaland 4,552.9 9,191.3 13,744.2
9. Sikkim 3,466.8 1,058.8 4,525.7
10. Tripura 7,411.5 5,716.1 13,127.6
11. Uttarakhand 16,245.1 4,063.0 20,308.1
Total 14,48,096.0 2,58,581.0 17,06,676.0

95
Monetary and Fiscal Table 17.4 : Inter-se Shares of States
Policies in India

States Share of all Share of Service Tax

Shareable Taxes* (per cent)
(per cent)
Andhra Pradesh 6.937 7.047
Arunachal Pradesh 0.328 0.332
Assam 3.628 3.685
Bihar 10.917 11.089
Chhattisgarh 2.47 2.509
Goa 0.266 0.270
Gujarat 3.041 3.089
Haryana 1.048 1.064
Himachal Pradesh 0.781 0.793
Jammu & Kashmir 1.551 Nil
Jharkhand 2.802 2.846
Karnataka 4.328 4.397
Kerala 2.341 2.378
Madhya Pradesh 7.12 7.232
Maharashtra 5.199 5.281
Manipur 0.451 0.458
Meghalaya 0.408 0.415
Mizoram 0.269 0.273
Nagaland 0.314 0.318
Orissa 4.779 4.855
Punjab 1.389 1.411
Rajasthan 5.853 5.945
Sikkim 0.239 0.243
Tamil Nadu 4.969 5.047
Tripura 0.511 0.519
Uttar Pradesh 19.677 19.987
Uttarakhand 1.12 1.138
West Bengal 7.264 7.379

Source: Report of Thirteenth Finance Commission, Government of India, 2010

Note: Exclusive Service Eax

 New disclosures have been specified for the Budget/MTFP including on tax
expenditure, public-private partnership liabilities and the details of variables
underlying receipts and expenditure projections.
 The Fiscal Responsibility and Budget Management (FRBM) Act needs to
specify the nature of shocks that would require relation of the targets thereunder.
96
 States are expected to be able to get back to their fiscal correction path by Fiscal Federalism
in India
2011-12 and amend their FRBM Acts to the effect.
 State Governments are to be eligible for the general performance and special
area performance grants only if they comply with the prescribed stipulation
in terms of grants to local bodies.
 The National Calamity Contingency Fund (NCCF) should be merged with
the National Disaster Response Fund (NDRF) and the Calamity Relief Fund
(CRF) with the State Disaster Response Funds (SDRFs) of the respective
States.
 A total non-plan revenue grant of Rs. 51,800 crore is recommended over the
award period for eight States. A performance grant of Rs. 1,500 crore is
recommended for three special category States that have graduated from a
non-Plan revenue deficit situation.
 An amount of Rs. 19,930 crore has been recommended as grant for
maintenance of roads and bridges for four years (2011-12 to 2014-15).
 An amount of Rs. 24,068 crore has been recommended as grant for elementary
education.
 An amount of Rs. 27,945 crore has been recommended for State-specific
needs.
 Amounts of Rs. 5,000 crore each as forest, renewable energy, and water
sector-management grants have been recommended.
 A total sum of Rs. 3,18,581 crore has been recommended for the award
period as grants-in-aid to States.
Source: Report of Thirteenth Finance Commission.

17.5.1 Critique of recommendations of the 13th Finance

Commission
The 13th Finance Commission (THFC) has broken new ground by building
incentives into the transfer mechanism. Most of its key recommendations have
been accepted by the government. The States stand to get a larger share of central
taxes than before. Apart from increasing their share of the divisible pool of tax
revenues from 30.5 per cent to 32 per cent, the Commission has proposed an
additional 2-2.5 per cent for local bodies. Grants-in-aid to States are projected
at Rs.315,581 crore over the next five years (2010-15). The shared taxes and
central grants together will take the overall devolution to States from 37.6 per
cent to 39 per cent of the central divisible tax revenues. The THFC does not
want any inconsistency between the amounts released to the States and the per
centage share in the net tax revenues recommended by it. The States have been
impressed upon to comply with the norms set by the Commission if they are to
avail themselves of the full benefit of certain transfers. It has called upon the
Centre not to lean heavily on surcharges and cesses since collections under
these heads are not shared with the States. The transfer formula, which emphasises
fiscal discipline on the part of the States, has been so worked out that non-Plan
revenue grants will be made available to fewer States. The system of incentive-
based transfer seeks to reward States that comply with the norms prescribed by
the THFC. However, given the political sensitivity of some of these proposals, the
accent is on achieving incremental gains for fiscal federalism. 97
Monetary and Fiscal Dr. M. Govinda Rao holds that the nine-point conditionality package proposed by
Policies in India
the TFC for the release of performance grants is the best way to ensure result-
based accountability, which, in turn, will lead to vibrant local self-governments. In
addition, the commission has also put in place very strong performance incentives.
A full 40 per cent of the total grant will be based on state governments fulfilling
a set of nine conditions. Given the magnitude of our problems, grants from the
Thirteenth Finance Commission will make a difference only at the margin. But such
grants are a signal to states that if they are willing to redirect their energies in
certain desired directions, they will find support from the FC. They are a signal
future FCs can build upon as well.
There is no doubt that the THFC’s approach has been different from that of earlier
UFCs, be it with regard to horizontal distribution, the revised road map for fiscal
consolidation, the design of grants to local bodies, or various other specific-
purpose transfers. Despite various shortcomings, many of the recommendations,
if implemented in the right spirit, will benefit the management of public finances in
the country. A major strength is the effort that has been made by the THFC to
move towards a more direct measure of fiscal capacity than per capita income and
its use in the horizontal distribution formula. However, the large number of specific-
purpose transfers tethered to conditionalities recommended by the THFC seriously
undermines the very idea of fiscally autonomous lower levels of government in a
multi-level fiscal system.
But, as the report of the Thirteenth Finance Commission (THFC) observes, there
are three additional challenges: Central revenue now increasingly includes a non-
shareable portion (e.g. sale of 3G spectrum, various cesses and surcharges),
putting states at a disadvantage; secondly, there is increasing mismatch between
fiscal capacity and fiscal needs of various states; and thirdly, with increased
urbanisation, the obligations of the third tier of government has been rapidly
increasing without any meaningful or automatic devolution to the third tier. The
increased salience of the state of local governments in the life of a citizen is
obvious, given that the states’ share constitutes 60 per cent of the combined
expenditure of States and the Centre. The report of the THFC provides a clear
articulation of the issues and approach followed, and the consideration that it has
used in recommending the fiscal transfers. For example, in determining vertical
devolution, it explicitly recognises greater fiscal needs of the states and the need
to insure them against regional shocks.
The Commission has earmarked Rs.50,000 crore of central grants to compensate
States for any revenue shortfall on account of switching to the Goods and Services
Tax. The compensation will be available even if there is no shortfall, provided the
State concerned adopts the GST model the THFC has prepared. This, however,
is going to prove contentious. The empowered committee of State Finance Ministers
has worked out its own model wherein tax rates are higher than in the THFC’s
version. The States want a much higher share of the divisible tax receipts to be
transferred to them. Nor will they be happy that the Commission has remained
silent on their long standing demands, namely decision-making powers in respect
of centrally-sponsored schemes. The THFC’s recommendation to impose a ceiling
on total government debt is timely. The government has accepted its suggestion to
put a cap on the combined debt of the Centre and the States at 48 per cent of
the GDP that is to be achieved by 2014-15.

98
17.5.2 Recommendations and Local Governments Fiscal Federalism
in India
Unlike its predecessors, the THFC upheld the view that local governments should
be supported through a predictable and buoyant source of revenue substantially
higher than in the past. Indeed, the most important recommendation of THFC is
its decision to relate grants to local governments to a share in the divisible pool
of the union tax revenue. In this way, the THFC has made local governments an
integral part of the public finance of the country. They are now recognised as
entities that are linked to the union tax revenue pool almost like the state
governments. Not just that, in absolute as well as relative terms, the local
government grant recommended by the THFC could be considered substantial, as
is shown in Table 17.5.
Table 17.5: Grant allocation of different Commissions to Local
Governments.
Commission Total Grant per cent to Divisible Pool
(Rs. In crore)
TFC (1995-2000) 5,380.93 1.38
EFC (2000-2005) 10,000 0.78
TWFC (2005-2010) 25,000 1.24
THFC (2010-2015) 87,519 2.28*
*De facto only 1.93 per cent.
Source: THFC Report

However, the local bodies will be beneficiaries of this recommendation only if its
implementation is based on actual revenues of the central government instead of
what has been projected in the THFC Report. The increase from the XII FC’s
Rs. 25,000 crore to the XIII FC’s Rs. 87,519 crore is more than 3.5 times. It
is important that the THFC goes beyond the usual official pontifications to carry
the decentralisation process forward. The local grant recommended by the THFC
has two components, a basic component and a performance-based component.
The performance grant allocated to each state is subject to them fulfilling a nine-
point conditionality package. This should help promote results-based accountability.
All of them are important and desirable measures to incentivise the states to carry
on and make decentralised governance durable. The THFC vis-à-vis the third tier,
despite several sins of commission and omission, seems to have walked somewhat
differently from its predecessors. Local governments are recognised as entities
entitled to a share in the union tax pool is something to rejoice about.
Check Your Progress 2
1) What is Finance Commission?
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99
Monetary and Fiscal 2) What is the need for a Finance Commission?
Policies in India
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3) What is the basis for recommendation of the Finance Commissions on
transfers?
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17.6 CHALLENGES POSED TO FISCAL

FEDERALISM
Fiscal transfers involve sharing of Central taxes and grants with the States. In
India, the key institutional arrangement that has guided fiscal federalism has
been the Finance Commission. Over time, the Indian system has also evolved
in a manner which is inconsistent with the principle of equalisation. Taking the
transfers done by the 12th and 13th Finance Commissions, it has also been shown
that on certain assumptions, 88-90 per cent of the equalisation of fiscal capacity
was achieved in the scheme of fiscal transfers. At the central level, there is a need
to focus more closely on the primary function, which is to deliver and implement
a prudent fiscal policy in consonance with the needs of overall development policy
making. In this matter, institutions charged with designing the overall development
policy framework of the country particularly, the Planning Commission, should
reflect on and address these issues. Fiscal interventions to correct against real and
perceived disparities generated by the growth process can only address the
symptoms and alleviate the consequences of not securing inclusive growth in all its
multiple dimensions.

17.6.1 Role of Planning Commission

The Planning Commission is an important body which has an important place in
Centre-State financial relations. The discretionary grants made under the
recommendations of the Planning Commission have been much greater than the
grants given under Article 275(1). As the settlement of the amounts of these grants
and later their actual issue depended upon detailed discussions between the State
Governments, the Planning Commission and the Central departments concerned,
the financial autonomy of the State was being steadily encroached. Another
feature of these grants is that they are available only for the plan period at the end
of which they become committed expenditure for which the States are exclusively
responsible. Naturally, they approach the Finance Commission and try to get a
greater share of revenue and larger grants. This constitutes a vicious circle.
This process was greatly intensified by the loans issued by the Centre. But as a
matter of fact a considerable portion of these loans have been spent for purposes
100 which do not yield any income, and their burden of interest and repayment fall on
the State revenues. From this, it will be clear that as a result of planning the Fiscal Federalism
in India
federal financial relations have become seriously distorted. Dr. P.V.
Rajamannar, Chairman of the Fourth FC, pointed out that the setting up of the
Planning Commission has in practice restricted the scope and functions of
the Finance Commission. It is also suggested that a permanent Finance
Commission is necessary condition for a satisfactory arrangement, for general
transfers to the States. The scope for discretionary transfers could be minimised
if the states are left by the Commissions in a position where they do not have
to look to the Centre for help even in trifling matters. Further, the purview of
the Finance Commission should be enlarged to include all non-Plan financial
transfers both on revenue and capital accounts. By implication, there will be
little room for discretionary transfers on non-Plan account. However, the need for
greater co-ordination between the two commissions is also emphasised.The
panel, headed by C. Rangarajan, was set up by the Planning Commission in 2010
to suggest measures for efficient management of public expenditure. The panel has
sought abolition of the present system of classifying government expenditure into
Plan and non-Plan, saying allocations should be the primary domain of the finance
ministry. The Planning Commission in its Eleventh Five-Year Plan (2007-12)
document had itself suggested doing away with the ‘illogical and dysfunctional’
distinction of Plan and non-Plan expenditure. ‘Plan’ expenditure is spent on
productive asset creation through central government-sponsored programmes and
flagship schemes, while ‘non-Plan’ refers to all other expenditures, such as those
on defence, subsidies and interest payments, including expenditure on establishment
and maintenance activities, such as salaries. The plan body-acting as the
government’s think-tank should primarily focus on growth prospects and broad
economic and policy framework.
Devolution of resources from the union to the states may be placed under three
categories: (i) transfers based on the recommendations of the Finance Commission;
(ii) transfers by way of assistance for execution of the plans recommended by the
Planning Commission, including centrally sponsored schemes; and (iii) others
consisting of small savings, loans, assistance for natural calamities, etc., canalised
through the Union Finance Ministry. Resources flowing from the union government
to the states through other channels, principally the Planning Commission, over
two-thirds of the revenue received by the states from the centre is still governed
by the dispensation of the FC. Bulk of central assistance (grants and loans) is
decided according to prescribed criteria, population being a major criterion,
backwardness of the states, other special problems also being other important
criteria. This is done under what is known as the Gadgil Formula or modified
Gadgil Formula. As Sarkaria Commission has observed: “It is not humanly
possible to derive foolproof formula which would make the totality of central
transfers confirm fully to the ideal of automatic and free-from interference devolution.
Some amount of flexibility and room for subjective judgement will have to be left
to the concerned institutions to deal with the specific situations as they arise. What
is really important is that the institutions involved should function in a fair
and non-partisan manner and take decision with due discernment and
expertise which are implicitly acceptable to the states”.

17.6.2 Trend towards Decentralisation

In its functioning it is considered to be a quasi-federal system because of the very
high concentration of powers with the central government. Recent economic and
political events, however, have paved the way for a greater degree of 101
Monetary and Fiscal decentralisation. Fiscal decentralisation is only the first step towards achieving
Policies in India
better living standards. Its effectiveness can be improved through greater fiscal
autonomy to panchayats and public participation to make PRIs’ fiscal operations
transparent, responsible and accountable. The PRIs have indeed taken root. But
to flourish into strong governments they need substantial nourishment in the
form of better institutional capacity, larger resources and, most importantly,
higher authority to spend them on improving local services. In the economic
sphere, the transition to a market oriented liberalisation and more open economic
environment has necessitated a greater degree of fiscal decentralisation. On the
political front, factors such as the end to single party rule, the emergence of
coalition of parties in power at the centre and increasing importance of regional
parties in the political affairs of the country have provided a favourable environment
for decentralised governance. Federal Constitutions everywhere are characterised
by an imbalance between the functional responsibilities and the financial powers
at different levels of government. Although the shareable pool has been enlarged,
the relative revenue accruals of the Centre and the States have not seen any major
change. There has been a long-term stability in the shares of the Centre and the
States in the combined tax revenues.

17.6.3 Inter-State Disparity

What will be the impact of the proposed Goods and Services Tax (GST) on the
vertical imbalance? Naturally, this would depend on the pattern and the rate of the
GST that will be put in place. The fiscal capacities of the States as measured by
the per capita income continue to vary widely even after six decades of federal
financial devolution and economic planning. The disparity between the highest and
the lowest is in the ratio of four-to-one. As a consequence, there is an uneven
provision of public services across different States, including merit goods such as
education and health services. This inter-State inequality on account of differences
in fiscal capacity is further compounded by two factors. The States with low
income levels have a large population. It means they have to transfer huge additional
resources if there has to be any impact at all. Further, some States have certain
cost disabilities because of the vastness of the area or other geographical and
climatic factors. An explicit equalisation methodology is yet to be developed
to tackle this systemic problem.
It is a matter of great potential concern that increases in disparities in growth
should not lead to demonstrable differences in access to opportunities and public
goods. This is not an issue which can be tackled using the limited instruments of
inter-governmental public finance available to the Finance Commission. It is a
wider policy issue on which we feel the institutions charged with designing the
overall development policy framework of the country, particularly the Planning
Commission, should reflect on and address. Fiscal interventions to correct against
real and perceived disparities generated by the growth process can only address
the symptoms and alleviate the consequences of not securing inclusive growth in
all its multiple dimensions.
There is an urgent need for reform of intergovernmental fiscal arrangements for
balanced regional development. A number of natural resource-abundant states in
India are lagging behind in development because of severe fiscal disabilities which
have not been offset by the transfers from the centre. Intergovernmental transfer
systems need to be reformed to correct the regional imbalances in
development. Thus, there is a dire need for coordination between various agencies
102 making transfers from the centre.
 Table 17.6 : Transfer of resources from the Centre to the States. Fiscal Federalism
in India
Receipts of the Central Government Resources transferred to the States
Year Revenue Capital Budgetary Total Shares Grants Loans Repayme Gross Net (11) as
Receipts receipts deficit/ receipts of States from the (gross) nt of transfers transfers % of 5
including (excld. draw Central in Centre to from the loans by to States to States
States repay- down of Govt. Central States & Centre to States & (6+7+8+9) (6+7+8+9)
share in ment of cash (2+3+4) taxes UTs States & UTs
taxes loans) balance of UTs
Central
Govt.
1 2 3 4 5 6 7 8 9 10 11 12
1970-71 4097 1124 285 5506 755 612 1028 658 2395 1737 31.5
1971-72 4972 1207 519 6698 944 891 1209 854 3044 2190 32.7
1972-73 5645 1240 869 7754 1067 947 1541 655 3555 2900 37.4 (40.6)
1973-74 6247 1504 328 8079 1174 952 1576 969 3702 2733 33.8
1974-75 7782 1583 721 10086 1224 1060 1093 507 3377 2870 28.5
1975-76 9674 2662 366 12702 1599 1289 1296 746 4184 3438 27.1
1976-77 10429 3671 131 14231 1690 1622 1481 656 4793 4137 29.1
1977-78 11590 2747 933 15270 1798 1961 1956 881 5715 4834 31.7
1978-79 13197 4203 951 18351 1957 2635 2769 892 7361 6469 35.3 (37.2)
1979-80 14746 3959 2433 21138 3406 2411 2762 844 8579 7735 36.6
1980-81 16621 6309 2577 25507 3792 2769 3146 917 9734 8817 34.6
1981-82 19848 7276 1392 28516 4274 2855 3460 1264 10589 9325 32.7
1982-83 22730 9111 1655 33496 4639 3635 4298 1444 12572 11128 33.2 (36.5)
1983-84 25739 12116 1417 39272 5246 4402 5059 1841 14707 12766 32.5 (33.1)
1984-85 30161 14041 3745 47947 5777 5220 6117 2454 17174 14720 30.7
1985-86 36698 17441 4937 59076 7491 7067 8473 2739 23031 20292 34.3 (45.1)
1986-87 42730 19215 8261 70206 6476 7744 7695 2909 24115 21206 30.2
1987-88 48001 22458 5816 76275 9598 9210 9414 3563 28222 24659 32.3
1988-89 55721 26365 5642 87728 10669 10076 10046 3316 30791 27475 31.3
1989-90 67196 26630 10592 104420 13232 8713 11311 3356 33256 29900 28.6
1990-91 71408 34542 11347 117297 14535 13293 14522 4653 42350 37697 32.1
1991-92 85460 35018 6855 127333 17197 16805 13199 3781 46201 42420 33.3
1992-93 97092 36088 12312 145492 20522 17943 13335 4639 51800 47161 32.4
1993-94 100840 54946 10960 166746 22241 20956 15263 5192 58460 53288 31.9
1994-95 119221 62362 961 182544 24840 20297 18807 4494 63944 59450 32.6
1995-96 143062 54428 9807 207297 29285 21577 19627 4790 70489 65699 31.7
1996-97 165532 54004 13154 232690 35061 23545 24031 6459 82637 76178 32.7
1997-98 190223 7828 66288 264339 43548 30452 14729 7125 88729 81604 30.9
1998-99 201503 101536 –144 302895 39145 25844 15935 9475 80924 71449 23.6
1999- 242527 121944 –13817 350654 43418 29837 21462 9791 94780 84989 24.2
2000
2000-01 256859 113359 6911 377129 51945 37684 20490 11691 110110 98428 26.1
2001-02 274018 82078 62923 419019 53628 42489 24528 14002 120545 106543 25.4
2002-03 307940 124918 10095 442953 56841 43167 28231 30303 128239 97936 22.1
2003-04 355212 99852 4796 459860 67366 48430 25449 61179 141245 80066 17.4
2004-05 400982 161676 63819 626477 80159 53873 24806 59737 158838 99101 15.8
2005-06 462186 83760 –64850 481096 95887 73677 5654 8799 175218 166419 34.6
2006-07 571012 104913 –25930 649995 122330 90185 4970 15338 217485 202147 31.1
2007-08 721116 160586 -310 881392 153600 108377 6706 8290 268683 260393 29.5
2008-09 724837 185584 –152193 758228 161979 124090 7115 2711 293184 290473 38.3
2009-10 774796 461919 9485 1246202 167992 140789 8913 3816 317694 313878 25.2
(R.E.)
2010-11 915530 421409 0 1336939 212557 154605 8252 4924 375414 370490 27.7
(B.E.)

Note: 1. Figures in brackets represent the ratios after adding the loans given to the States for
clearing their overdrafts/deficits with the R.B.I. to the total receips of the Central
Govrnment as well as to the gross transfer to the States.
2. Article 270 of the constitution, was retrospectively amended with effect from 1st April,
1996. Under the provision of the Constitution (80th Amendment) Act, 2000, prescribed
share of States in the net proceeds of Central taxes and duties does not form part of
the Consolidated Fund of India.

The relative position of transfer of funds from the Centre by Finance Commission
and Planning Commission including Union ministries are given in Table 17.6. Column
6 indicate share of States in Central Taxes whereas Column 7 indicates Grants
which includes Grants-in-Aid recommended by the Finance Commission as well
as the Planning Commission. Column 8 indicates the loans given through Planning
Commission to the States and UTs.
The service delivery mechanism of local bodies throughout the country is grossly
inadequate. This is due to a gross shortage of funds with urban local bodies.
Despite fiscal reforms, there are serious shortcomings in the resource transfer
mechanism from the centre to the states. The states are also not making enough 103
Monetary and Fiscal of an effort to mobilise their own resources. There is an urgent need for
Policies in India
institutional and governance reforms, if the issue of inter-regional inequity is
to be seriously addressed.
Check Your Progress 3
1) Why is Planning Commission considered a distortion in Fiscal Federalism?
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2) Identify the major issues in union-state financial relations.
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3) How are the recommendations of Thirteenth Finance Commission different
from the previous one?
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17.7 LET US SUM UP

The Constitution (Eightieth Amendment) Act, 2000 has altered the pattern of
sharing of Central taxes between the Centre and the States in a fundamental
way. The Finance Commission is now required to recommend such per centage
of taxes or duties referred to in the new Article 270 that may be assigned to the
States and also recommend the manner in which these may be distributed among
the States. It needs to be added that for evolving a satisfactory institutional
arrangement to take care of the problem in centre state financial relations, and
correcting the deficiencies which have come to notice, one has to look beyond the
constitutional provisions as they exist at the moment. Perhaps the autonomy and
independence of the lower levels of government will always be limited, because
economic policies designed by the central government often have serious
implications for the budgets of provincial and local governments. The federal
fiscal structure must be able to deal with the budgetary consequences of central
government policies for the provincial and local governments and vice versa.
Therefore, if the institutions which have evolved over the years and come to play
an important role in the nation’s economic development (like the Planning
Commission and the NDC) are found lacking in constitutional sanction, it may not
be right to reject all that has been done by them as illegal but to find ways in which
their role can be defined with some clarity and regulated by law.
The Finance Commission (FC) constitutes a pillar of India’s federal structure,
mediating in the sharing of central revenues with the states and the inter se
104
distribution among the constituents of the union. Moreover, the THFC has sought
to define the approach needed to address the issues that would help to correct Fiscal Federalism
in India
aberrations that have set in the course of time. Though its efforts do not go very
far in charting a new path, the report tries to break away from the past in important
ways, which may have a profound impact on the finances of the government at all
levels in the coming years.

17.8 EXERCISES
1) State in brief the principles of federal finance. How far these principles are
adhered to in the Centre-State financial relations in India?
2) What is Finance Commission? How is it different from the Planning
Commission? Make an evaluation of the recommendations of the Thirteenth
Finance Commission.
3) “States should have their due share in responsibilities as well as rights”. In the
light of this statement, bring out the important issues in Centre-State relations
in India.
4) “The question of Centre-State relations has become the focal point of discussion
for a number of reasons”. Comment on this statement and point out the
reasons for conflict between Centre and States.

17.9 KEY WORDS

Centrally sponsored schemes: Schemes init iated by the Cent re but
implemented by the States. The extent of
Central Assistance to such schemes is normally
around 50 per cent of the total outlay. The
expenditure on these schemes, in the nature
of conditional grants by the centre to the states,
has assumed a dimension much beyond that
sanctioned by the 1969 National Development
Council (NDC) resolution which laid down a
ceiling on them of 1/6th or 1/7th (i.e. 14.17
per cent) of total plan assistance to the States.
Gadgil Formula : A formula of plan assistance to States adopted
since the Fourth Plan (1969-74) which
provided that distribution of plan assistance
to the States should take five elements into
account. This is named after Professor D.R.
Gadgil, the then Vice-Chairman of the Planning
Commission.
Gap-filling Approach : Assistance to States for rectifying imbalances
– vertical or horizontal – is essentially in the
nature of a device to bridge a budgetary gap.
However, the phrase ‘gap-filling approach’
epit omises t he pract ice of Finance
Commissions of recommending grants-in-aid
to States on the basis of estimated gap
between forecasted expenditure and receipts
(inclusive of tax shares) on revenue account.
Horizontal Imbalance, i.e., : The imbalance between the expenditure 105
Monetary and Fiscal Horizontal Federal Fiscal requirements and own revenues of different
Policies in India
Imbalance constituent units of a federation mainly on
account of differences in fiscal capacities
arising out of regional economic disparities.
Rectifying horizontal imbalance means
promoting regional equalisation.
Inter-State Council : In 1990, the Government took the step of
invoking the constitutional provision (Article
263) and forming an Inter-State Council
charged with the duty of : “(a) inquiring into
and advising upon disputes which may have
arisen between States; (b) investigating and
discussing subjects in which some or all of the
States or the Union and one or more of the
States, have a common interest; or (c) making
recommendations upon any such subject”. The
idea is to provide an institutional mechanism
through which a more integrated approach to
Centre-State relations could emerge. There
would be three meetings of council on a regular
basis every year, and that all questions coming
up for discussion will be decided by
consensus. The council will be a
recommendatory body.
Statutory Transfer : Transfer of resources from Centre to States
under tax devolution and Article 275 grants-
in-aid at the recommendations of the Finance
Commission.
Tax Effort : Judged from ratio of tax revenue to State
income.
Vertical Imbalance, i.e., : The non-correspondence between the
Vertical Federal expenditure requirements of the functions and
Fiscal Imbalance the extent of revenue raised from the sources
assigned to the unit governments as compared
to the national government in a federation.

17.10 SOME USEFUL BOOKS

Chakraborty, Pinaki (2010): ‘Report of the 13 th Finance Copmmission:
Introduction and Overview’, Economic & Political Weekly, November 27.
Chelliah, R.J. & Associates (1981): Trends and Issues in Federal Finance in
India, New Delhi, Allied Publishers.
Government of India (2009)Gulati, I.S. (edited) (1987): Report of the Thirteenth
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17.11 ANSWERS OR HINTS TO CHECK YOUR

PROGRESS EXERCISES
Check Your Progress 1
i) See Section 17.2
ii) See Section 17.3
iii) See Sub-section 17.3.4
Check Your Progress 2
i) See Section 17.4
ii) See Section 17.4 relevant portions
iii) The Finance Commission takes into account various parameters for deciding
its awards.
The TFC, for instance, assigned specific weights to population, income distance,
poverty, geographic area and tax efforts of the states to decide the quantum of
taxes that should be transferred to the states. The previous panel had considered
infrastructure development also as one of the parameters. New panels can change
the weight assigned to each of the parameter given changes that take place during
a five year period of the award.
Check Your Progress 3
i) See Sub-section 17.6.1
ii) See Section 17.6
iii) See Sub-section 17.5.1
107