Model Answer
0 min readIntroduction
Fiscal ties between the Union and States in India represent the complex web of financial interactions that underpin the country’s federal structure. Historically, these ties have been characterized by a degree of vertical imbalance, with the Union government possessing greater revenue-raising powers. The Constitution (specifically Articles 268-293) lays down the framework for revenue distribution, grants-in-aid, and borrowing powers. However, recent economic measures, particularly the implementation of the Goods and Services Tax (GST) in 2017, coupled with evolving Finance Commission recommendations and a growing reliance on cesses and surcharges by the Union, have significantly reshaped this landscape, leading to both opportunities and challenges for state finances.
Impact of the Goods and Services Tax (GST)
The GST, intended as a landmark reform to create a unified national market, has had a mixed impact on fiscal ties. Initially, states experienced revenue losses due to the transition and the subsuming of their indirect tax powers. The Union government assured states of compensation for five years (until June 2022) through a GST Compensation Cess.
- Revenue Neutrality: While the GST Council aimed for revenue neutrality, many states faced revenue shortfalls, particularly during the initial years and exacerbated by economic slowdowns.
- Compensation Cess: The GST Compensation Cess, levied on luxury and demerit goods, proved insufficient to fully compensate all states, leading to demands for extension and alternative mechanisms.
- Council Dynamics: The GST Council, a constitutional body representing both Union and States, has become a crucial forum for fiscal negotiations. However, concerns remain regarding the Union’s dominance in decision-making, especially regarding rate changes and policy interpretations.
Impact of Finance Commission Recommendations
The Finance Commission plays a pivotal role in determining the vertical and horizontal distribution of tax revenues between the Union and States. Successive Finance Commissions have influenced the share of states in the divisible pool of taxes.
- 15th Finance Commission (2020-2026): The 15th FC recommended a reduced share of states in the divisible pool (41% compared to 42% recommended by the 14th FC), citing the need to provide for newly formed Union Territories. This reduction was met with resistance from several states.
- Criteria for Devolution: The 15th FC placed greater emphasis on demographic performance (population control) and tax effort, potentially benefiting states with better performance on these fronts. This shift in criteria sparked debate about equity and fairness.
- Grants-in-Aid: The Commission also recommended performance-based grants to states for specific sectors like health, education, and urban local bodies, incentivizing reforms and improved service delivery.
Impact of Increased Reliance on Cesses and Surcharges
The Union government has increasingly relied on cesses and surcharges – taxes levied for specific purposes – as a source of revenue. Unlike taxes that are shared with states, cesses and surcharges are retained entirely by the Union.
- Reduced Share for States: The increased use of cesses and surcharges effectively reduces the divisible pool of taxes, thereby diminishing the states’ share in central revenues.
- Examples: The imposition of higher cesses on petrol and diesel, and the health and education cess, have significantly impacted state finances.
- Constitutional Concerns: Some argue that the excessive reliance on cesses and surcharges circumvents the constitutional scheme of fiscal federalism, as it bypasses the principles of revenue sharing.
Emerging Trends and Challenges
Several emerging trends are further complicating fiscal ties:
- Competitive Federalism: The emphasis on performance-based grants and rankings encourages competitive federalism, where states compete for resources and recognition.
- Cooperative Federalism: Simultaneously, the GST Council and other forums promote cooperative federalism, requiring consensus-building and collaboration between the Union and States.
- Debt Sustainability: The COVID-19 pandemic exacerbated the fiscal stress on both the Union and States, raising concerns about debt sustainability and the need for fiscal consolidation.
- Regional Disparities: The impact of economic measures varies across states, potentially widening regional disparities and creating new challenges for equitable development.
| Aspect | Pre-GST | Post-GST |
|---|---|---|
| Revenue Control | States had independent control over indirect taxes | Limited control; GST rates decided by GST Council |
| Revenue Source | Multiple indirect taxes | Integrated GST, CGST, SGST |
| Revenue Sharing | States retained full revenue from their taxes | Revenue shared based on GST Council decisions and compensation mechanism |
Conclusion
The new economic measures have undeniably altered the fiscal ties between the Union and States in India. While GST aimed for simplification and integration, its implementation revealed complexities and revenue challenges for states. The evolving role of the Finance Commission and the increasing reliance on cesses and surcharges have further reshaped the financial landscape. Moving forward, a more collaborative and equitable approach to fiscal federalism is crucial, ensuring that states have adequate resources to meet their developmental needs while upholding the constitutional principles of revenue sharing and financial autonomy. A transparent and predictable fiscal framework will be essential for fostering sustainable economic growth and strengthening the cooperative spirit of Indian federalism.
Answer Length
This is a comprehensive model answer for learning purposes and may exceed the word limit. In the exam, always adhere to the prescribed word count.