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Insights into Editorial: Another look at fiscal transfers

Insights into Editorial: Another look at fiscal transfers


The Indian Constitution lays down the functions as well as taxing powers of the Centre and States.

The Constitution of India has provided provisions which enable the Union and the States to work in coordination and to levy and collect taxes through systematic arrangements.

In our country during the independence struggle, provincial autonomy was regarded as an integral part of the freedom movement.

The fiscal federal arrangements that are provided in the Constitution adopted were largely the logical extensions of the Government of India Act, of 1935.


After Independence, Strong Centre: Centralisation Process:

However, after Independence, several compulsions, which included defence and internal security, led to a scheme of federalism in which the Centre assumed greater importance.

Also, in the immediate period following Independence, when the Centre and all States were ruled by the same party and when many of the powerful provincial leaders migrated to the Centre, the process of centralisation gathered further momentum.

At that time, Economic planning at a nation-wide level helped this centralising process.


Fiscal Imbalance between States and Centre:

  • Today, the Central government is held responsible for everything that happens, including, for example, agrarian distress.


  • The centrally sponsored schemes, which have ballooned in recent years, have ‘encroached’ on the territory of States.


  • Over years, the performance of the Central government is judged not only on the basis of actions taken which fall strictly in its jurisdiction but also on initiatives undertaken in the areas which fall in the Concurrent and even State lists. Centralised planning has

something to do with it.


  • For Instance, according to the Finance Commission Reports, In 2010-11, in the combined revenue receipts of the Centre and States, the share of the Centre was 64.68%.


  • After transfer, the share came down to 40.20%. In the case of the States, their share before transfers was 35.32%. After the receipts of transfers the share of States went up to 59.80%. Thus, the shares got reversed.


  • In 2016-17, the share of the Centre after transfers was 33.37% and that of the States was 66.63%.


  • In the case of total expenditures, the share of the Centre in 2014-15 was 41.14% and that of the States was 58.86%. The ultimate position appears reasonable. The question may be on the mode of transfers.


  • At present tax and grant transfer is being determined by both finance commission and central government.


  • There is need of robust mechanism through which funds are allocated or transfer to states.


  • Therefore, while viewing the responsibilities of the Centre and States we must take a broader view than what is stipulated in the Constitution.


Problem of Fiscal Imbalances: Solution is Fiscal federalism:

Fiscal federalism refers to the division of responsibilities with regards to public expenditure and taxation between the different levels of the government.

In India, the Constitution recognises the problem of fiscal imbalances. It provides for the appointment of the Finance Commission by the President of India every five years to resolve them by making recommendations on tax devolution and grants in aid of revenues.

The objective of transfers is to ensure minimum standards of public services.

One important aspect of fiscal federalism is the determination of the specific fiscal instruments that would enable the different levels of government to carry out their functions.

Having a Fiscal Federalism mechanism allows the government to optimize their costs on economies of scale, because in this manner, people will get public service which they prefer, and there will be no unnecessary expenditure.



There are issues relating to horizontal distribution. Equity considerations have dominated the allocations.

However, the ability of bringing about equalisation across States in India has limitations. Even the relatively richer States have their own problems and they feel ‘cheated’ because of the overuse of the equity criterion.

An appropriate balancing of criteria is needed particularly in the context of the rise in unconditional transfers.

Of course, appropriate balancing is what all Finance Commissions are concerned about.

The freedom given to the States must be limited. It is important to note that the levy by the Centre and States together should be reasonable.


Way Forward: Some suggestions

The time has come for the Constitution to be amended and the proportion of shareable taxes that should go to the States fixed at the desired level.

The shareable tax pool must also include cesses and surcharges as these have sharply increased in recent years.

Fixing the ratio at 42% of shareable taxes, including cesses and surcharges, seems appropriate.

Another possible route is to follow the practice in the U.S. and Canada: of allowing the States to levy tax on personal income, with some limitations.

Since one of the concerns is that resources do not match functions, this may be a way out.

But, as in the U.S., the scheme should be simple and ride on federal income tax, that is, just a levy on the income assessed by federal authorities.

Adoption of any one of these alternatives will avoid friction between the Centre and the States. Perhaps the first alternative of constitutionally fixing the ratio is the easiest.