Fiscal Federalism


    In News 

    Recently ,Chief Ministers expressed their concern about dwindling State revenues in a NITI Aayog meeting and the States  sought a higher share in the divisible pool of taxes and an extension of GST compensation.

    About Fiscal Federalism: 

    • It deals with the division of financial powers as well as the functions between multiple levels of the federal government. 
    • It has within its ambit the imposition of taxes as well as the division of different taxes between the Centre and the constituent units. 
    • Similarly, in the case of joint collection of taxes, an objective criterion is determined for the fair division of funds between the entities. 
    • Usually, there is a constitutional authority (like Finance Commission in India) for the purpose to ensure fairness in the division.

    Historical Background 

    • Historically, India’s fiscal transfer worked through two pillars, i.e., the Planning Commission and the Finance Commission
    • But the waning of planning since the 1990s, and its abolition in 2014, led to the Finance Commission becoming a major means of fiscal transfer as the commission itself broadened its scope of sharing all taxes since 2000 from its original design of just two taxes — income tax and Union excise duties.

    Present Challenges 

    • The share of the States in divisible pool is shrinking despite their carrying a higher burden of expenditure
    • High share of committed expenses: Status of States’ financial health had taken a turn for the worse with the implementation of the Ujwal DISCOM Assurance Yojana, farm loan waivers, as well as the slowdown in growth in 2019­-20. 
    • Pandemic impact has worsened the fiscal positions of State governments. 
    • Dependence on centre : The major source of revenue of other States is Central transfers. The Constitution grants the Union government more revenue raising powers while the States are tasked to undertake most of the development and welfare related responsibilities. 
    • Imbalance : According to the 15th Finance Commission’s report, in FY19, the Union government raised 62.7% of the total resources raised by the Union government and States, while States had borne 62.4% of the aggregate expenditure. This allocation of taxation powers and expenditure responsibilities results in an imbalance and  the gap between the share recommended by the FC and the actual devolution has widened.
    • Inequality:  India’s fiscal federalism driven by political centralisation has deepened socio-economic inequality, belying the dreams of the founding fathers who saw a cure for such inequities in planning.


    • Former Governor of Reserve Bank of India (RBI) C. Rangarajan has underscored the importance of fiscal federalism at various levels in current Indian democracy.
    •  Distribution of resources was also essential alongside decentralisation of powers for achieving economic growth.
    • The Union government needs to invest resources towards facilitating effective consultation with States as a part of the lawmaking process.
    •  It is critical that the Union establishes a system where citizens and States are treated as partners and not subjects.
    • Recommendations of PV Rajamannar committee of 1971 needs to be considered which suggested that the Finance commission be made a permanent body.

    Latest Developments

    • The Center Released over ?1.16 lakh crore to States, equivalent to two monthly instalments of tax devolution, to help front-load State governments’ capital spending abilities in this financial year.


    • States are now owed ?35,266 crore on account of GST compensation for June 2022, the last month for which States were promised assured revenues as part of the compact to transition to the GST regime in 2017.
    • The Finance Ministry has said those dues will be paid from collections of the GST compensation cess, whose levy has been extended till March 31, 2026.


    Mains Practise question

    [Q] Critically analyse present challenges associated with India’s fiscal federalism.