Meaning of Fiscal Federalism

It is the study of how expenditures and revenues are allocated across different layers of
administration i.e. Central government, state and local governmentsIt is concerned with
understanding which functions and instruments are best centralised and which are best
decentralised.

According to Joseph E. Stiglitz', fiscal federalism is concerned with the division of economic
responsibilities between the Central (or federal) government and the states and local governments.
Federalism covers issues that go beyond economics.

CENTRE-STATE FINANCIAL RELATIONS IN INDIA

The Constitution of India has clearly laid down the division of responsibilities (functions) involving
expenditure and division of powers to raise resources between the centre and the states as also
local bodies

A. Division of Functions

The principle underlying the division of functions assigns countrywide tasks to the centre and
state/region. Similarly the tasks of local importance are assigned to municipalities in towns and
panchayats in villages.

Central Government Functions: The several functions of the central government are classified into
developmental and non- developmental functions. Developmental functions are the ones which
promote growth and welfare of the people, for e.g. provision of social and community services
(education, public health, science and technology, labour and employment etc.); economic services
(agriculture and allied services, industry and minerals, transport and communications, foreign trade
etc.); and grants in aid to states for developmental purposes.

Non-developmental functions include maintenance of law and order (police, defence); maintenance
of external relations; grants to states for non-developmental purposes.

State Government Functions: The various responsibilities of the states are also grouped under two
categories: developmental and non-developmental. Developmental functions include: social and
community services; economic services etc.

Non-developmental functions include administrative services, payment of pensions, interest

Justification for the Division

The above-mentioned division of functions is justified on the following grounds:

() Defence and communication services are to be provided uniformly throughout the country and
thus should be the responsibility of the centre.

(ii) Benefits accrue due to economies of scale in the provision of these services due to the large size
of the country.
(ii) Critical areas such as foreign investment and foreign trade, which require a national agenda, are
with the centre.

(iv) Further, services which differ from region to region like agriculture, are assigned to the states.

Problems The existing division of functions has the following problems:

1. There is over lapping of functions in important areas like education and health.

2. Many of the centrally sponsored schemes do not provide the required freedom and autonomy to
the regions in respect to designing and implementation and thus do not benefit the targeted groups.

B. Division of Resource Raising Powers

To meet the expenditures involved in the performance of functions, the governments at different
levels have been assigned powers to raise resources.

Receipts of Central Government: There are various sources of receipts of the central government
classified into revenue receipts and capital receipts. Among the revenue receipts the most important
is the tax revenue. A part of the tax receipts is statutorily transferred to the states as per the
recommendations of the Finance Commission. The various types of taxes allotted to the centre may
be listed under three categories:

Taxes on income and expenditure, which include income tax,corporation tax and expenditure tax
Taxes on property and capital transactions which cover estate duty, wealth tax etc.

Taxes on commodities: A major change in the indirect tax structure was made with the
implementation of The Goods and Services Tax (GST) on 1 July 2017. Since GST is a destination based
tax, an end user consuming any goods or services is liable to pay it. The tax is received by the State in
which the goods or services are consumed and not by the state in which such goods are
manufactured.

(1) Central GST (CGST) is a tax levied on intra-state supplies of both goods and services by the
central government and governed by the CGST Act.

(2) State GST (SGST) will also be levied on the same intra-state supply, but will be governed by the
state government. This implies that both the Central and the State governments will agree on
combining their levies with an appropriate proportion for revenue sharing between them.

(3)ntegrated GST (IGST) is a tax levied on all inter-state supplies of goods and services and will be
governed by the IGST Act. Tax will be shared between central and state governments. Apart from tax
revenue there are other sources of revenue receipts. These include dividends from railways, posts
and telegraphs, RBI, public sector undertakings and interest receipts on loans given to states Apart
from tax revenue there are other sources of revenue receipts. These include dividends from
railways, posts and telegraphs, RBI, public sector undertakings and interest receipts on loans given
to states As regards capital receipts, the government has the legal power to borrow from the
domestic as well as the international markets, as also from world institutions and foreign
governments.

Receipts of State Government: Like those of the Centre, receipts of states are classified into revenue
and capital receipts. The revenue receipts come mainly from taxes on agricultural income,
profession tax, property and capital transactions like stamp and registration, land revenue, urban
immovable property tax and surcharge on cash crops. Besides these direct taxes, states have the
power to levy indirect taxes like those on commodities and services such as GST.
Besides tax revenue, states have other sources of receipts on revenue account. These are non-tax
revenues such as interest receipts, dividends from state enterprises etc.Then there are receipts on
capital account, which are loans taken from the market in the form of bonds and securities, and
loans, which flow from the centre. In addition there are receipts like share in central taxes, grants in
aid and other receipts of funds from the centre for centrally sponsored schemes (CSS).

Financial Imbalance

Inspite of the clearcut division of the powers and the financial resources between the Centre and
states, there is an imbalance in the division of resources. This imbalance is in favour of the Centre, It
has been observed that while the responsibilities of the states have increased over the years, their
revenue resources have not increased substantially.

Transfer of Resources from Centre to States

The constitution itself has recognised the finance inadequacy of states and, therefore, the
constitution has made a provision for the transfer of resources from the centre to states. These
transfers are of three types:

Transfer of a part of tax proceeds from centre to the states. This is done through the agency of
Finance Commission.

1) Transfer in the form of grants and loan from centre to states. These too are done through
the Finance Commission.

The above scheme of transfer does not solve the problem of financial imbalance.

C. Finance Commissions

Article 280 of the Constitution of India has made provision for the appointment of a Finance
Commission. The Finance Commission (Miscellaneous Provisions) Act was passed in 1951. According
to the provisions of the Act, the Commission is appointed every five years. It includes a chairperson
and four other members.

The functions of the Finance Commissions are:

(a) To recommend the distribution of net tax proceeds and allocation of shares of such proceeds
between the Union and the States.

(b) Grants-in-aid recommendations for covering the gap between current revenues and
expenditures of the States, and for removal of regional disparities between the States. The
Commission also recommends special purpose grants to any State.

(c) The Finance Commission may look into and study specific problems and issues in the interest of
healthy and sound financial relations between the Centre and States, on the advice of the President.
These issues include extent of indebtedness of States, debt relief measures and special expenditures
required to be made by States.

So far 15 Finance Commissions have been constituted. The 15th Finance Commission was
constituted on 27 November 2017 under the chairmanship of Sri N. K. Singh.

Some of the major distinctive features of the 15th Finance Commission are:
(a) Recommending monitorable performance criteria for important national flagship programmes.

(b) Examining the possibility of setting up a permanent non- lapsable funding for India's defence
needs.

(c) The re-organisation of the state of Jammu and Kashmir into two Union Territories, one of Jammu
and Kashmir and one of Ladakh presents new challenges of fiscal distribution.

The 15th Finance Commission submitted its first report of recommendation’s for FY 2020-21 in
February 2020 and the second report with recommendations for 2021-26 on February 2021.