Model Answer
0 min readIntroduction
Fiscal federalism in India refers to the arrangement of financial relations and distribution of resources between the Union and state governments, aimed at achieving both efficiency in resource allocation and equity across regions. While the Indian Constitution, through the Seventh Schedule, clearly demarcates legislative and taxation powers among the Union, State, and Concurrent Lists, the Union Government often extends its financial contributions to subjects falling under the State and Concurrent Lists. This intervention, primarily through mechanisms like tax devolution, grants-in-aid, and Centrally Sponsored Schemes (CSS), has profound implications for the fiscal autonomy and developmental priorities of the states, leading to a complex interplay of cooperative and competitive federalism.
The Union Government's financial involvement in subjects constitutionally assigned to the State and Concurrent Lists is a distinctive feature of Indian fiscal federalism. This involvement is facilitated by several constitutional provisions, including Article 270 (distribution of taxes), Article 275 (statutory grants-in-aid), and Article 282 (discretionary grants for public purposes). Over the years, Centrally Sponsored Schemes (CSS) have become a prominent instrument for this intervention, influencing various sectors like health, education, and rural development.
Pros of Union Government Contribution to State and Concurrent Lists
- Reduces Vertical Fiscal Imbalance: The Indian Constitution assigns greater revenue-raising powers to the Union, while states bear significant expenditure responsibilities, especially in welfare and development sectors (e.g., public health, agriculture). Union contributions bridge this inherent fiscal gap. The 15th Finance Commission noted that states had only 37.3% of resources but were responsible for 62.4% of the expenditure in 2018-19.
- Ensures National Minimum Standards: Through schemes in sectors like education (e.g., Sarva Shiksha Abhiyan) and health (e.g., Ayushman Bharat), the Union Government can ensure a certain baseline of services and welfare standards across all states, addressing regional disparities and promoting inclusive growth.
- Promotes Inter-State Equity: Financial transfers, especially through Finance Commission recommendations, aim to equalize opportunities and reduce regional imbalances by providing more funds to less developed states or those with specific needs.
- Facilitates Macroeconomic Stability: During economic slowdowns or crises, the Union can provide timely financial support to states, preventing a collapse of public services and enabling states to undertake counter-cyclical fiscal measures. For instance, increased tax devolution in January 2025 aimed to accelerate states' capital spending.
- Leverages Technical Expertise and Best Practices: Union agencies can provide technical guidance, research, and best practices in designing and implementing schemes, especially in complex areas, which may be beneficial for states with limited capacities.
- Addresses Spillover Effects: For subjects in the Concurrent List or those with inter-state externalities (e.g., environmental protection, disaster management), central coordination and funding can lead to more effective and synchronized policy outcomes.
Cons of Union Government Contribution to State and Concurrent Lists
- Erosion of State Autonomy and Fiscal Space: Centrally Sponsored Schemes often come with strict guidelines and conditionalities, limiting states' flexibility to tailor programs to local needs and priorities. States are compelled to prioritize central schemes even if they conflict with their own developmental agendas.
- Increased Dependence on Centre: States' reliance on central transfers has increased significantly. From FY16 to FY25, 23-30% of states' total revenue came from central transfers, up from 20-24% in the preceding 15 years. This dependence can undermine states' financial self-sufficiency.
- Distortion of State Priorities: The matching grant requirement for many CSS can divert state funds from their own priority sectors, leading to an imbalance in expenditure. This "one-size-fits-all" approach may not be optimal for a diverse country like India.
- Politicization of Fund Allocation: Allegations of political bias in the allocation of discretionary grants or special packages to states aligned with the ruling party at the Centre can strain Centre-State relations and undermine cooperative federalism.
- Reduced Share of Devolvable Taxes and Rise of Cesses: The share of states in the gross tax revenue (GTR) has decreased from 35% in 2015-16 to 30% in 2023-24. Simultaneously, the share of non-devolvable cesses and surcharges in the Union's tax revenue has increased from 5.9% in 2015-16 to 10.8% in 2023-24, further reducing the divisible pool for states.
- Fiscal Irresponsibility and Debt Concerns: While states are held accountable by their own Fiscal Responsibility and Budget Management (FRBM) Acts, the incentives created by conditional central grants might sometimes lead to less prudent fiscal management by states, knowing that some liabilities will be shared. The combined debt of Centre and states exceeds 80% of GDP, limiting fiscal space.
- Issues with GST Implementation: While GST aimed to foster cooperative federalism, its implementation has led to revenue shortfalls for states (estimated 19-33%) and delays in compensation payments, exacerbating cash flow issues.
Key Constitutional Provisions and Mechanisms
| Article | Description | Relevance to Fiscal Federalism |
|---|---|---|
| Article 246 | Divides legislative powers into Union, State, and Concurrent Lists (Seventh Schedule). | Defines the scope of governance for both Union and states, inherently impacting fiscal responsibilities. |
| Article 270 | Distribution of net proceeds of taxes between Union and states. | Mandatory sharing of taxes recommended by the Finance Commission, enhancing states' untied resources. |
| Article 275 | Statutory grants-in-aid to states. | Parliament can provide grants to states "in need of assistance," based on Finance Commission recommendations, addressing revenue deficits. |
| Article 280 | Constitutes the Finance Commission every five years. | Primary constitutional body for recommending vertical and horizontal devolution of finances. |
| Article 282 | Empowers Union or a State to make grants for any public purpose. | Used extensively for Centrally Sponsored Schemes, even for subjects outside legislative competence, raising concerns about its original intent. |
| Article 293 | Borrowing by states. | States can borrow within India, but with Union consent if they owe money to the Centre, imposing limits on state fiscal autonomy. |
Conclusion
The Union Government's financial contributions to subjects in the State and Concurrent Lists are an indispensable aspect of India's fiscal federalism, serving to mitigate vertical imbalances and promote national developmental goals. However, this intervention, particularly through Centrally Sponsored Schemes, often comes at the cost of state fiscal autonomy, distorting priorities and potentially fostering an unhealthy dependence. Moving forward, strengthening cooperative federalism requires a re-evaluation of the role of conditional grants, increasing the share of untied transfers, ensuring transparency in resource allocation, and granting states greater flexibility in adapting central schemes. A balanced approach that respects constitutional division of powers while addressing national imperatives is crucial for the healthy functioning of India's federal structure.
Answer Length
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