Discuss The Financial Relationship Between Center-State in india

The financial relationship between the Center and the States in India is a crucial aspect of Indian federalism, as it governs how revenues and expenditures are divided between the two levels of government. This relationship is designed to ensure that states have sufficient financial resources to meet their administrative responsibilities, while the central government retains enough control to maintain national unity and economic stability. The financial relationship is outlined in the Constitution of India, primarily under Articles 268 to 293, and is supported by various constitutional mechanisms such as the Finance Commission, Planning Commission (replaced by NITI Aayog), and GST Council.

Key Features of the Center-State Financial Relationship

1. Division of Taxing Powers (Seventh Schedule)

The Seventh Schedule of the Indian Constitution divides the taxing powers between the Center and the States through three lists: the Union List, the State List, and the Concurrent List.

• Union List: The Center has the exclusive power to levy taxes on items of national importance such as customs duties, excise duties, corporation tax, and income tax (except agricultural income). These taxes provide the bulk of the central government’s revenue.
• State List: The States can levy taxes on items of local or regional importance, such as land revenue, stamp duty, sales tax (replaced by GST for most goods and services), state excise, and taxes on agricultural income.
• Concurrent List: Although there are no specific taxes in the Concurrent List, the Center and States can legislate on subjects related to economic policies and taxation under specific circumstances.

2. Types of Taxes

• Taxes Levied by the Center but Collected and Appropriated by the States (Article 268):
  • Some taxes, such as stamp duties on certain financial documents and excise duties on medicinal and toilet preparations, are levied by the Center but are collected and appropriated by the States. This ensures that states have access to certain tax revenues.
• Taxes Levied and Collected by the Center but Assigned to the States (Article 269):
  • Taxes such as those on the sale or purchase of goods in the course of inter-state trade or commerce, or taxes on the consignment of goods in inter-state trade, are levied and collected by the Center but assigned to the states.
• Taxes Levied and Collected by the Center but Shared with the States (Article 270):
  • Taxes like income tax (other than agricultural income) and union excise duties are levied and collected by the Center but shared with the states based on recommendations by the Finance Commission.

3. Grants-in-Aid (Article 275)

• Under Article 275, the Parliament can provide grants-in-aid to states that need financial assistance, particularly states with lower levels of revenue. These grants are meant to enable states to meet administrative costs and support welfare programs. They are especially important for underdeveloped and special category states that have lower tax bases and higher developmental needs.

4. Loans and Borrowing Powers

• The Center can make loans to states and can also guarantee loans raised by states on the open market. However, states can borrow only with the consent of the Center when they have outstanding debts owed to the central government (Article 293).
• States are allowed to borrow independently within India for their own development purposes, but external borrowing requires central government approval to prevent fiscal mismanagement.

5. Distribution of Financial Resources

• The Constitution provides mechanisms to balance the distribution of financial resources between the Center and the States through tax devolution and grants-in-aid. The aim is to ensure that states with lower revenue-generating capacity receive sufficient financial support to meet their expenditure needs.

Constitutional and Institutional Mechanisms for Center-State Financial Relations

1. Finance Commission (Article 280)

• The Finance Commission is a constitutional body appointed by the President every five years to recommend how revenues should be divided between the Center and the States. It plays a critical role in ensuring fiscal federalism by making recommendations on:
  • The distribution of taxes between the Center and States.
  • The principles governing grants-in-aid.
  • Measures to improve the consolidated fund of states.
  The Finance Commission uses various criteria, such as population, income levels, tax effort, and fiscal discipline, to recommend the vertical and horizontal distribution of financial resources.

2. Goods and Services Tax (GST) Council (Article 279A)

• The GST Council, established by the 101st Constitutional Amendment Act in 2016, represents a significant development in Center-State financial relations. It is responsible for making decisions on GST-related issues, including tax rates, exemptions, and revenue-sharing.
  • Composition: The GST Council consists of the Union Finance Minister as the chairperson, the Union Minister of State for Finance, and the finance ministers of all states.
  • Revenue Sharing: The GST is a dual tax structure, with both the Center and the States levying GST on goods and services. The revenue is shared between the Center and the States as per the formula recommended by the GST Council.
  • Compensation to States: To compensate states for the potential loss of revenue due to the transition to GST, the Center provides compensation to states for five years (2017–2022), based on a guaranteed 14% annual growth in tax revenues.

3. NITI Aayog

• The NITI Aayog (National Institution for Transforming India), which replaced the Planning Commission in 2015, plays a key role in facilitating cooperative federalism and financial planning. It acts as a think tank and advises the Center and States on development strategies, resource allocation, and fiscal management.
  • Unlike the Planning Commission, which had the authority to allocate funds to states for development projects, NITI Aayog serves as a platform for states to share their financial concerns and contribute to national policymaking.

4. Consolidated Funds and Contingency Funds

• Both the Center and States have their own Consolidated Funds and Contingency Funds, into which all revenues are deposited. These funds are used for government expenditure, and no money can be withdrawn without legislative approval. The states manage their own finances, but certain grants from the Center, such as centrally sponsored schemes, are also disbursed from these funds.

Tensions and Challenges in Center-State Financial Relations

Despite the constitutional provisions and institutional mechanisms, certain challenges persist in Center-State financial relations:

1. Vertical Imbalance

• Vertical fiscal imbalance refers to the mismatch between the revenue-raising capacity and expenditure responsibilities of the Center and the States. The Center controls the majority of high-revenue taxes (such as income tax and customs duties), while states have limited revenue sources. However, states are responsible for delivering many essential services like health, education, and law and order.
  • To address this imbalance, the Finance Commission recommends the devolution of central taxes to the states. However, states often argue that the devolution is insufficient to meet their growing expenditure needs.

2. Horizontal Imbalance

• Horizontal fiscal imbalance refers to the uneven distribution of resources across states due to differences in their tax bases and developmental needs. Richer states like Maharashtra and Gujarat generate higher revenues, while poorer states like Bihar and Uttar Pradesh struggle with lower revenues.
  • The Finance Commission uses criteria such as population, area, income levels, and backwardness to address these disparities, but many states believe that the formulas used for devolution of taxes are not equitable.

3. Dependence on Centrally Sponsored Schemes (CSS)

• Centrally Sponsored Schemes (CSS) are national programs funded primarily by the central government but implemented by the states. Examples include schemes like Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) and Pradhan Mantri Awas Yojana (PMAY).
  • States often argue that they have limited flexibility in using these funds and that the schemes impose a significant administrative burden on state governments.

4. Goods and Services Tax (GST) Compensation Issues

• After the implementation of GST, states have become increasingly dependent on the compensation provided by the Center to make up for any shortfall in tax revenues. However, there have been disputes regarding delays in the payment of compensation, particularly during the COVID-19 pandemic, when states faced fiscal stress.

5. Borrowing Restrictions

• Article 293 imposes restrictions on the borrowing powers of states. States need the Center’s permission to borrow if they have existing loans from the central government. This can limit the financial autonomy of states, especially those that require additional funds for development or welfare projects.

6. Political Conflicts

• Political differences between the ruling parties at the Center and in the states can lead to tensions in the allocation of resources. States governed by opposition parties may claim that they receive fewer funds or are excluded from certain centrally funded schemes. This often exacerbates tensions in fiscal federalism.

Recent Trends and Developments in Center-State Financial Relations

1. 15th Finance Commission (2020-2025)

• The 15th Finance Commission made key recommendations on tax devolution and grants for the period 2020-2025. It reduced the percentage of tax devolution to the states from 42% (as recommended by the 14th Finance Commission) to 41% due to the creation of the Union Territories of Jammu and Kashmir and Ladakh. The Commission also emphasized performance-based grants and sector-specific grants, especially for health, education, and rural infrastructure.

2. Increased Focus on Performance-Based Grants

• Recent Finance Commissions have introduced performance-based grants to encourage fiscal discipline and improved governance at the state level. These grants are given to states based on their performance in areas like tax efforts, population control, water management, and ease of doing business.

3. COVID-19 Pandemic and Fiscal Stress

• The COVID-19 pandemic placed severe fiscal stress on both the Center and the States. The increased expenditure on healthcare and social welfare, combined with a drop in revenue collection, led to greater demands from states for financial assistance. The central government relaxed borrowing limits for states during the pandemic, allowing them to borrow up to 5% of their Gross State Domestic Product (GSDP), up from the usual 3% limit.

4. Debates on Fiscal Federalism

• There has been growing debate on the need for greater fiscal autonomy for states. Many states have called for more decentralization of financial powers, especially in light of rising expenditure on healthcare, education, and welfare schemes. The Southern states in particular have raised concerns that the current distribution formula does not account for their higher levels of development and economic contribution.

Conclusion

The financial relationship between the Center and the States in India is fundamental to the functioning of Indian federalism. While the Constitution provides a detailed framework for the division of financial powers and resources, challenges related to fiscal imbalances, political conflicts, and the changing economic landscape continue to affect this relationship. Going forward, there will be a need for greater cooperation, transparency, and flexibility in fiscal management to ensure both national unity and state autonomy.