KLE Law College, Bengaluru

(Constituent College of K L E Technological University, Hubballi)

Name of the Student SAHANA A. KARKAL

Student Registration No 03FL23MLC008

Name of the Programme LLM Constitutional Law

Semester III Semester

Name of the Course Centre State Relations

Course Code 21LLCT201

Assignment topic Distribution of Fiscal Powers between

Submitted to Dr. Mahesh R. Sharanappa

Signature of the Student Signature of the Course Teacher

I would like to thank my course teacher Dr. Mahesh R. Sharanappa for giving me this opportunity to
do in-depth research on the topic “Inquiries by Legislative Committees” and also for guiding me
throughout whenever needed. I also would like to extend my sincere gratitude to the library
department of our college for facilitating remote access to online resources without which
researching would have been extremely difficult in the given circumstances.

[STUDENT’S SIGNATURE]
 DECLARATION
I, SAHANA A. KARKAL, III Semester, LLM- Constitutional Law, do hereby declare that I have
completed the assignment “Distribution of Fiscal Powers between Centre and States” and the same
has not been published in any other source. The information submitted is true and original to the best
of my knowledge.

[STUDENT’S SIGNATURE]
 TITLE: DISTRIBUTION OF FISCAL POWERS BETWEEN CENTRE AND STATES

Sl. No. PARTICULARS Page No.

01 Introduction 01-03

02 Constitutional Framework 04-08

03 Distribution of Fiscal powers between Centre and States 09-18

04 Recent reforms in Fiscal Federalism in India and their impact 19-23

05 Need of Rethinking India’s Fiscal Federalism 24-28

06 Conclusion 29-33

Bibliography 34-35
 PART 1

INTRODUCTION

To maintain a cordial relationship between the Union and the States, decentralization of some
functions of state government is necessary. The federal structure, which divides authorities and
responsibilities between the Union and the individual States, strengthens this. India, which has
frequently been referred to as having a quasi-federal system of governance due to the fact that it has
a unitary center but also granted its States certain essential functions and autonomy, differs from
nations like the United States of America and Australia, which adhere strictly to federalism.

India does not strictly function on the lines of what constitutes a purely federal state. According to
Dr. Ambedkar, “The Indian Constitution is a Federal Constitution inasmuch as it establishes what
may be called a Dual Polity which will consist of the Union at the Centre and the States at the
periphery each endowed with sovereign powers to be exercised in the field assigned to them
respectively by the Constitution. Yet it avoids the tight mould of federalism in which the American
Constitution was caught, and could be both unitary as well as federal according to the requirement
of time and circumstances.”1

In order to provide public services that most closely reflect voter preferences, fiscal federalism
enables governmental organizations to realize cost efficiency through economies of scale.
From an economic perspective, it establishes a single, common market that encourages more
economic activity. The extent of decentralization and its relationship to development level,
population heterogeneity, harmonization of preference patterns, distribution of functions and
funding among governmental levels, resolution of vertical and horizontal imbalances, and
institutional mechanisms for conducting intergovernmental relations are the main causes of the
issues. Federal finance refers to resource elasticity and sufficiency. This suggests that there are
enough resources available to fulfill constitutional obligations, and elasticity suggests that resources
can be increased to meet the government's expanding demands. In the case of States, the division of
tax authority has had the practical consequence of denying both of these attributes. The
Constitution's provisions pertaining to taxation authority create a vertical imbalance between the
federal government and the states. This imbalance has resulted from the desire to create a common
economic space in the nation and the fear that states may erect barriers inside it if they have more
authority, rather than from an attempt to strengthen the Center. 2

1
VII, Constituent Assembly Debates, 33, 34
2
B. P. R. Vithal and M. L. Sastry, Fiscal Federalism In India 72, (Oxford University Press, Michigan, 2001)

1
Fiscal federalism encompasses the division of functions and financial relations among levels of
government in accordance with public policies to achieve laid down targets. It examines the
division of responsibilities including finances among the federal, state, and local governments.
Fiscal federalism is part of broader discipline of public finance. This term was introduced in 1959
by the German-born American economist Richard Musgrave. It refers to shared taxation and
spending policies. In any federation there is division of powers and responsibilities between the
centre and federating units. There is a system of devolution of financial resources too.

In India, the Government of India Act 1935 is considered to have established the basic structure of
fiscal federalism. It separated the revenues and finances of provincial governments from federal
government and detailed the distribution of financial resources and grants in aid to provinces. Post-
independence, the Constitution laid down clear cut division of powers at central and state
government levels. As you are aware, the Seventh Schedule of the Constitution provides this in the
form of Union, State and Concurrent lists. The Constitution has also provided for provisions for
levy and collection of taxes. Some are levied and collected by the centre and assigned to states,
while some are levied by the centre but collected and utilised by the states. 3

Fiscal federalism involves examining and stabilising the horizontal and vertical imbalances in
centre-state financial relations. Horizontal imbalances arise due to variations in the levels of
development attained by the states. Vertical imbalances arise due to vertical asymmetry in taxation
powers vested with different levels of government. They are generally stabilised through various
types of transfers, grants, and transfers. In Indian context these issues are examined by the Finance
Commission. The new policy initiatives in the form of Ayushman Bharat, New Education policy,
and so on have increased the responsibilities of central and state governments. The core of fiscal
federalism lies in the fiscal transfers on a vertical level from central to governments at state and
local levels.

States may differ in their degree of development due to a variety of variables, including their
historical origins, natural resource endowment, and public service norms. These factors ultimately
cause horizontal imbalances between the States. In order for the States and the Union to fulfill their
respective obligations under the Constitution, a successful federation requires both to have
sufficient financial resources. In order to accomplish this, our Constitution contains detailed
provisions that primarily follow the framework of the Government of India Act, 1935, regarding the
allocation of tax and non-tax revenues as well as the authority to borrow. These provisions are
3
Mr. Richard Hemming, “Fiscal Federalism in Theory and Practice” available at
[Link] (last visited on Jan 5, 2025)

2
complemented by provisions for grants-in-aid that the Union provides to the States. Instead of
splitting the financial resources into two impenetrable compartments as would be the case under a
typical federal government, the goal of this division is to distribute the resources fairly amongst the
two federation units.4

The Supreme Court has given a fitting interpretation to this arrangement in the case of Coffee Board
v. C.T.O.5, “Realising the limitations on the financial resources of the States and the growing needs
of the community in a welfare State, the Constitution has made specific provisions empowering
Parliament to set aside a portion of its revenues for the benefit of the States, not in stated
proportions but according to their needs. The resources of the Union Government are not meant
exclusively for the benefit of the Union activities. The Union and States together form one organic
whole for the purposes of utilisation of the resources of territories of India as a whole.”

The enumeration of taxation powers placed in the Union List includes: tax on income other than
agricultural income, excise duties, customs and corporate tax. Service tax had been included in view
of diminishing importance of customs. The State List contains land revenue, excise on alcoholic
liquor, tax on agricultural income, estate duty, tax on sale or purchase of goods, tax on vehicles, tax
on professions, luxuries, entertainment, stamp duties etc. The Concurrent List does not include any
taxation powers. There have been two important points of debate:

(i) That there is a mismatch between the functions allocated to the centre and to the states,
their powers of taxation, and
(ii) That the more buoyant tax areas have been assigned to the centre. But, it has also been
pointed out that “the Constitution recognizes that the division of resources and functions
between the Union and the states was such that there would be imbalance between them”
and that “the Finance Commission periodically corrects the imbalance bringing about an
alignment between them”

4
DURGA DAS BASU INTRODUCTION TO THE CONSTITUTION OF INDIA 369 ( 22nd ed.).
5
AIR 1971 SC 870

3
 PART 2

CONSTITUTIONAL FRAMEWORK

Fiscal federalism refers to the distribution of financial powers and responsibilities between different
levels of government—in India, between the Centre and the States. The Constitution of India
establishes a framework for fiscal federalism to ensure that the resources are distributed equitably
and that both the Centre and the States are empowered to manage their respective financial affairs
while maintaining unity in the nation's fiscal governance. The constitutional provisions, such as those
in Articles 270, 275, 280, 282, 293, and the Seventh Schedule, serve as the foundation for this
framework. These provisions define the powers and responsibilities of the Union and State
Governments in relation to taxation, revenue distribution, financial transfers, borrowing powers, and
the establishment of institutions such as the Finance Commission. This article provides an in-depth
look at the key constitutional provisions that shape India's fiscal federalism.

Article 270: Distribution of Taxes Levied by the Centre

Article 270 of the Indian Constitution deals with the distribution of taxes collected by the Union
Government between the Centre and the States. This article reinforces the role of the Finance
Commission in determining how the taxes levied by the Centre, such as the income tax and other
central taxes, are shared with the States. It aims to address fiscal imbalances between the Centre and
the States by allocating a share of central taxes to States based on their financial needs.

Under Article 270, the President, on the advice of the Finance Commission, determines the
percentage of central taxes to be distributed to the States. The Finance Commission makes its
recommendations for the period of five years, based on certain criteria such as the population size,
area, income levels, and the economic condition of the States. This provision ensures that the
financial resources of the Centre are shared with the States in a way that reflects their needs for
public services, infrastructure development, and social welfare programs. 6

The distribution of central taxes is an essential aspect of India's fiscal federalism, as it ensures that
States with lower economic resources are provided with a greater share of central taxes to ensure
equitable development across regions. It also serves to address the fiscal imbalances caused by the
unequal distribution of resources between States, thereby promoting national unity and inclusive
growth.

6
O. C. Sud, “Fiscal Ambiguities Between Centre And States”, 74 The Indian Journal of Political Science 290
(2013)

4
Article 275: Grants-in-Aid to States

Article 275 of the Indian Constitution empowers the Union Government to provide grants-in-aid to
the States from the Consolidated Fund of India. The grants are provided to States that may face
financial difficulties due to various reasons, such as economic backwardness, special needs, or
natural calamities. These grants help to ensure that States have sufficient funds to maintain a
minimum level of public services, such as healthcare, education, and infrastructure, despite their
fiscal constraints.

Article 275 establishes the Union Government's role in assisting States, particularly those in need, to
bridge their fiscal gaps and promote regional equity. The grants are provided based on the
recommendations of the Finance Commission and are intended to meet the financial requirements of
States that may not have the necessary resources to undertake developmental projects or to finance
social welfare schemes. These transfers help in achieving the goals of equitable growth and poverty
alleviation across the country, especially in backward and underdeveloped regions.

The grants-in-aid system helps to maintain a financial balance between the Union and States,
ensuring that States can fulfill their constitutional responsibilities despite their fiscal limitations. By
providing financial support to States with special needs, Article 275 also ensures that the principle of
cooperative federalism is upheld, as it encourages the Centre to assist States in their developmental
endeavors.

Article 280: Establishment of the Finance Commission

Article 280 of the Indian Constitution establishes the Finance Commission, a critical institution that
plays a central role in determining the distribution of financial resources between the Centre and the
States. The Finance Commission is tasked with making recommendations on the sharing of taxes,
grants-in-aid, and other fiscal transfers between the two levels of government.

The Finance Commission is constituted by the President every five years and is headed by a
chairman, usually a retired judge or a distinguished expert in the field of finance and economics. Its
primary responsibility is to recommend the allocation of resources between the Union and the States,
taking into account various factors such as the population, area, economic condition, fiscal capacity,
and developmental needs of each State. The Commission also recommends measures to improve the
financial health of both the Centre and the States.7

7
M. P. Jain, Indian Constitutional Law 703 (Lexis Nexis, Haryana, 8th edn., 2018)

5
The Finance Commission plays a crucial role in promoting fiscal equity, as its recommendations are
designed to ensure that fiscal transfers are made in a fair and just manner. It also aims to ensure that
States have adequate financial resources to meet their developmental and social obligations while
enabling the Centre to maintain its role in national governance. By making periodic
recommendations, the Finance Commission provides a mechanism for adapting the distribution of
financial resources to changing economic conditions, thereby promoting a dynamic and responsive
fiscal federal system.

Article 282: Allocation of Funds for Projects Benefiting States

Article 282 of the Indian Constitution allows the Union Government to allocate funds for specific
projects that benefit States or regions. This provision empowers the Centre to undertake development
projects or fund schemes that have a national interest or that could promote the welfare of particular
States or regions.8

Under Article 282, the Centre can provide financial assistance to States for infrastructure
development, social welfare programs, or other public projects that may not be adequately funded by
the State Governments themselves. This article facilitates cooperative federalism by promoting
collaboration between the Centre and the States, ensuring that resources are allocated for projects that
benefit the entire country or address regional disparities.

While this provision gives the Centre considerable discretion in funding projects, it also serves to
strengthen cooperative governance by ensuring that the Union Government can respond to regional
needs and priorities. In this way, Article 282 contributes to fostering collaboration between the Centre
and States, promoting national unity and balanced regional development. 9

Article 293: State Borrowing Powers

Article 293 of the Indian Constitution regulates the borrowing powers of State Governments. It
requires States to seek the consent of the Union Government before borrowing from external sources
or taking new loans if they have outstanding loans from the Centre. This provision has important
implications for the fiscal autonomy of States, as it places a restriction on their borrowing capacity.

The primary objective of Article 293 is to ensure that States do not over-borrow and compromise
their fiscal stability. By requiring the Centre’s consent for borrowing, this provision provides a
safeguard against excessive borrowing and helps maintain national fiscal discipline. However, it has

8
Supra note 7
9
Ibid

6
also been a point of contention for some State Governments, as it limits their ability to raise funds
independently for critical development projects, especially during times of financial distress.

In practice, States often face constraints in meeting their financial needs due to the requirement of
prior approval from the Centre for borrowing. This provision can, therefore, reduce the financial
autonomy of States, particularly in the context of large infrastructure projects or welfare programs
that require substantial funding. Some critics argue that greater flexibility should be provided to
States in terms of borrowing, particularly in the context of devolution of more fiscal powers to States.

The Seventh Schedule: Division of Subjects and Taxation Authority

The Seventh Schedule of the Indian Constitution lays down the distribution of subjects and taxation
authority between the Union and the States. It divides the responsibilities of governance into three
lists: the Union List, the State List, and the Concurrent List. The Union List contains subjects on
which only the Union Government can legislate, such as defense, foreign affairs, and interstate trade.
The State List contains subjects on which only State Governments have the authority to legislate,
such as police, public health, and local governance. The Concurrent List includes subjects on which
both the Union and State Governments can legislate, such as education, marriage, and criminal law. 10

The Seventh Schedule also defines the taxing authority of both the Union and State Governments.
While the Union Government can levy taxes on subjects in the Union List, States have the power to
impose taxes on subjects in the State List. Both levels of government can levy taxes on subjects in the
Concurrent List, though the Union Government’s laws take precedence in case of conflict. This
division of taxation authority between the Centre and States ensures that both levels of government
can generate revenue to meet their respective financial needs.

The Seventh Schedule is fundamental to India’s fiscal federalism, as it defines the scope of financial
autonomy for both the Centre and the States. It allows States to raise revenue from taxes on local
subjects, ensuring that they have the resources to manage local governance and public services. At
the same time, it allows the Union Government to maintain a unified national framework by
controlling key areas such as defense, foreign trade, and national security. 11

The constitutional provisions related to fiscal federalism in India, as outlined in Articles 270, 275,
280, 282, 293, and the Seventh Schedule, create a structured framework for managing financial
relations between the Union and State Governments. These provisions are designed to ensure a

10
V. N. Shukla, Constitution Of India 847 (Eastern Book Company, Lucknow, 12th edn., 2013)
11
Ibid

7
balance between centralization and decentralization of fiscal powers, promoting both national
cohesion and regional autonomy. By establishing mechanisms such as the Finance Commission and
outlining specific provisions for tax distribution, grants-in-aid, and borrowing powers, the
Constitution ensures that States have the resources necessary to meet their development needs while
maintaining fiscal discipline.

However, the implementation of these provisions has evolved over time, with challenges emerging
related to resource allocation, fiscal autonomy, and the changing nature of federal governance in
India. As the country continues to modernize and decentralize governance, there is an ongoing need
to assess the effectiveness of these constitutional provisions and to adapt them to meet the demands
of a rapidly changing economy and political landscape. Ultimately, a balanced and responsive fiscal
federalism is essential for ensuring inclusive growth, equitable development, and the continued
prosperity of India.12

12
Ms. Palak Jagtiani, “Fiscal and Cooperative Federalism Under The Indian Constitution”, 1 GLS Law Journal
(2019)

8
 PART 3

DISTRIBUTION OF FINANCIAL RESOURCES

The Constitution of India makes a distinction between the legislative power to levy a tax and the
power to appropriate the proceeds of a tax so levied and hence, the powers of a Legislature in these
two respects are not identical. Thus, for instance, while the State Legislature has the power to levy
an estate duty in respect of agricultural lands under entry 48 of List II, the power to levy an estate
duty in respect of non- agricultural land belongs to Parliament under Entry 87 of List I. Similarly, it
is the State Legislature which is competent to levy a tax on agricultural income under Entry 46 of
List II, while the Parliament has the power to levy income-tax on all incomes other than agricultural
under Entry 82 of List I.

Constitutional provisions for distribution of revenues between the union and the states in India are
as follows:

Article 26813 provides for duties levied by the Union but collected and appropriated by the States.
The revenue from stamp duties on bills of exchange, cheques, promissory notes, bills of lading,
letters of credit, policies of insurance, transfer of shares, etc. is collected and appropriated by the
States. Though all of these items are included in the Union List and the Union government can levy
taxes on them, yet all these duties are collected by the States and form part of the revenue of the
State who collects them.

This means that though the excise duties and stamp duties specified in Entries 84 and 44 of list III
will be levied by the Union , that is to say the Union will impose these duties and determine the
rates thereof, - the States will collect these taxes within their respective territories and appropriate
the net proceeds.

The power to levy a stamp duty is a concurrent power under Entry 44 of List III alone. The power to
prescribe the rates of stamp duty exclusively falls within this Entry and Entry 63 of List II for
instruments in that respective Entry. In any case, a law relating to stamp duty can be made both by
the State Legislature and Parliament subject to Article 254. 14 Parliament has no power to make laws
with respect to stamp duty payable at the time of an advocate’s enrolment as this is not a matter
enumerated in List I Entry 91.15

13
The Constitution of India, art. 268.
14
Bar Council v. State of UP, AIR 1973 SC 231
15
In re Rupendra Pershad Saigal, AIR 1958 AP 63

9
In the Union Territories, however, it is the Union which will collect these taxes as well as
appropriate the net proceeds.

Clause 2 of Article 268 provides for the proceeds of duty leviable within any State. The net
proceeds of the taxes specified in clause 1 being wholly appropriated by the State, so far as they are
levied in those States, such proceeds will not be entered into the Consolidated Fund of India, but
will be directly allotted to those States and will form part of the Consolidated Funds of those States.
The opening words of Article 266(1) also support this conclusion.

Article 269 provides for taxes levied and collected by the Union but assigned to the States. This
category contains items of revenue which fall under the exclusive jurisdiction of the State like land
revenue, stamp duty (except on documents included in the Union List), succession duty and estate
duty, taxes on goods and passengers carried by road or inland waters, consumption or sale of
electricity, tolls, taxes on employment, duties on alcoholic liquors for human consumption, opium,
India hemp and other narcotic drugs, taxes on the entry of goods into local area, taxes on luxuries,
entertainments, amusements, betting and gambling, etc.

Article 269 corresponds to s. 137 of the Government of India Act, 1935 while Art 268 makes
provision for levy of certain taxes by Parliament and collection by the States, the taxes and duties
mentioned in Art. 269 are to be levied and collected by the Government of India. The net proceeds
thereof are, however assigned to and distributed among the States in accordance with the principles
that may be formulated by the Parliament by law. The taxes mentioned in Articles 268 and 269 are
really sources of State revenue and are intended to form part of the Consolidated Fund of the
respective States. 16

The Constitution makers, however, thought it desirable to have a uniformity of the law as regards
the levy, rates, incidence and collection of these taxes and, therefore, provision for their imposition
by Parliament was made by including the subjects in legislative List I of the Seventh Schedule.
Under Article 271, the Parliament has power by law to levy surcharge in respect of the taxes and
duties referred to in Articles 269 and 270 for the purposes of the Union and when such a levy is
made, the amount so collected would exclusively form part of the Consolidated Fund of India. In
exercise of the power under Article 269, Parliament has framed the Central Sales Tax Act, 1956.

Clause 1 of Article 269 provides that while the States will themselves collect and directly
appropriate the taxes (though levied by the Union) specified in Article 268(1), - the taxes specified

16
Gauthaman V, “Preserving Fiscal Autonomy In The Indian Social Policy Landscape: Addressing
Centralization And Inter-Governmental Structures”, 8 NUJS Journal of Regulatory Studies (2020)

10
in the present Article will be collected by the Union but the net proceeds raised from the States shall
be wholly assigned to them and distributed amongst them according to principles formulated by
Union legislation. But such assignment to the States is mandatory. These taxes and duties were
specified in sub-clause (a) to (h) of clause 1 of this Article as it stood before the amendment. But
those raised from the Union Territories shall be retained by the Union (Clause 2).

No inter-State consignment tax has been imposed by parliament in implementation of clause (1) (h)
in spite of the recommendation made in the Report of the National Commission to Review the
working of the Constitution submitted to Central Government on 31-03-2002.

The explanation clauses (a) and (b) are exhaustive to cover taxes on inter-State trade or commerce
of different categories. These clauses are not attracted unless there is

a. Imposition of a tax
b. On inter-State trade or Commerce17

Neither a State Legislation nor a judge made law can artificially appoint a situs of sale so as to
create territorial nexus attracting applicability of tax legislation enacted by any State Legislature
and tax on inter-State sale in breach of s. 3 of Central Sales Tax Act, 1956 read with Articles 286 (2)
and 269 (1) of the Constitution. Neither State Legislation nor any Stipulation in any contract can fix
situs of sale within a State or artificially define the completion of sale or create territorial nexus to
tax inter-State sale unless permitted by an appropriate central legislation.18

Corresponding taxing power has been conferred on Parliament by inserting entry 92B in List of
Seventh Schedule by the Constitution (46th Amendment) Act, 1982. This entry reads as follows-

“Taxes on consignment of goods (whether the consignment is to the person making iyt or to any
other person) where such consignment takes place in the course of inter-State trade or commerce”.

In Good Year India Ltd., v. State of Haryana19, Supreme Court held that though the State purported
to levy a sale or purchase tax, the taxing event was due to neither the purchase of the raw msaterials
nor their manufacture, nut the dispatch of a new commodity outside the taxing State. It was
therefore, a tax on the “consignment” of the goods. The tax imposed by a State on a mere dispatch
of goods by a manufacturer to his own branches outside the State was ‘ultravires’ because it was a
‘consignment tax’ which fell within the exclusive competence of Parliament under Entry 92B of
List I.
17
Harihar Prasad Debuka v. State of Bihar, AIR 1987 Patna 175
18
State of A. P. v. National Thermal Power Corp., AIR 2002 SC 1895
19
AIR 1990 Sc 781

11
In exercise of the power conferred by clause 3 of Article 269, Parliament has enacted s.3 of Central
Sales Tax Act, 1956, which lays down the principles for determining when a sale or purchase takes
place in the course of inter-State trade or commerce. Before the coming into force of this Act, the
expression ‘inter-State trade’ had to be construed in its natural sense of a trade involving movement
of goods from one State into another.

Since the coming into force of this Act, the interpretation has to be made in accordance with the
provisions of the Act.20 “Sale” is defined in s.2 (g) of the Central Sales Tax Act as meaning – “Any
transfer of property in goods by one person to another for caste or for deferred payment or for any
other valuable consideration and includes a transfer of goods on the hire-purchase or other system
of payment by instalment, but does not include a mortgage or hypothecation of or a charge or
pledge goods.” This means that a transaction of sale is subject to tax under the Central Sale Tax
only on the completion of the sale and that a mere contract of sale is not within the definition of sale
in s. 2 (g).

In Cement Marketing Co. v. State of Mysore, it was said that a would not come within the purview
of clause (a) of s. 3 unless the contract itself involves the movement of the goods from the seller or
the manufacturer across the border, from one State to another.

For a sale to be termed in the course of inter-State trade, three essential ingredients have to be
satisfied –

1. There must be a contract for sale incorporating a stipulation express or implied regarding inter-
State movement of goods.
2. The goods must actually move from one State to another, pursuant to such contract of sale, the
sale being the proximate cause of movement.
3. Such movement of goods must be from one State to another State where the sale concludes.

Article 270 provides for taxes levied and collected by the Union and distributed between the Union
and the States. It includes all taxes and duties referred to in the Union List, except the duties and
taxes referred to in Articles 268 and 269, respectively, surcharge on taxes and duties referred to in
Article 271 and any cess levied for specific purposes under any law made by Parliament shall be
levied and collected by the Government of India. The basis of distribution in this case is decided by
the Parliament by law.

20
S. T. Corpn., v. State of Mysore, 1967 SC 585

12
Article 270(1) differs from Article 269 (1) in this that while under Article 269 (1) the assignment to
the States is of the whole of the net proceeds of the taxes mentioned therein, whereas under the
present Article it is only a share of the taxes mentioned herein (Entry 82, List I) that will be
assigned to the States. But the sharing under the present article is mandatory while the sharing
under Article 272, post, is permissive.

The reason why provision for sharing of the proceeds of non-agricultural income tax between the
Union and the States was provided by the Constitution may be explained in the words of the Third
Finance Commission.21

While clause 1 of Article 270 enunciates the principle of sharing, clause 2 read with clause 3 and 4
lays down the procedure therefor. There was a major reconstruction of the scheme of tax-sharing
between the Centre and the States in the year 2000. Till the year 2000, only a few Central taxes
were sharable between the Centre and the States. The Tenth Finance Commission suggested that the
present system be replaced by a new scheme in which the States shared in the total tax revenue of
the Centre. The Commission also suggested that the share of the States in the gross receipts of the
Central taxes be fixed at 29% and the ratio be reviewed after fifteen years.

The Commission saw many advantages in the new scheme, as for example, the State can share in
the aggregate buoyancy of Central taxes; the Central Government can pursue tax reforms without
the need to consider whether a tax is sharable with the States or not. The new Article 270 (1)
provides that the net proceeds of all taxes and duties referred to in the Union List, levied and
collected by the Centre shall be distributed among the Union and the States except the following –

1. Duties and taxes referred to in Articles 268, 268A and 269 respectively.
2. Surcharge on taxes and duties referred to in Articles 271 and
3. Any cess levied for specific purposes under a law made by Parliament.

Clauses 2 and 3 of Article 270 provide for the assignment of income tax. In determining the fund to
be distributed between the Union and the States two items are to be excluded from the net proceeds
of the income tax –

a. Proceeds of the tax attributable to Union territories,22 as determined under clause 3;

21
Report of the Finance Commission, 1961, pp. 16, 34.
22
Kaniyan v. I. T. O., AIR 1968 SC 637

13
Clause (4) (b) makes it clear that until the constitution of the Finance Commission under Article
280, post, the percentage of assignment to the State was to be determined by order of the President.
Under this power, the President made the Constitution (Distribution of Revenue) Orders, 1950 and
1951.

The new Article 270 does not fix the percentage of the net proceeds of the Central taxes which must
be distributed among the States since Article 270 (2) merely says: “Such percentage as may be
prescribed.” In practice, the presentation of the distributable percentage of the Central taxes has
been left to be settled by the Finance Commission.

The Eleven Finance Commission has fixed this percentage at 29.5%. Thus, the 29.5% of the Central
revenue has to be transferred to the States. The Commission has also worked out the Scheme of
inter se distribution of the tax revenue among the various States keeping in view a number of
considerations such as population, collection, State budgetary deficits, State effort to improve its
resource base, economy in State administration, fiscal discipline, etc. The Twelfth Finance
Commission (2205-2010) raised the share of states in Shareable taxes from 29.5% to 30.5%.

The revenue transferred to the States by way of tax sharing is unconditional which they use as they
like. Thus, the major burden of taxation falls on the Centre while the States enjoy a part of the fruits
of its effects. Politically and economically the Centre is in a much stronger position to tax than the
States are. From the State’s point of view, the disadvantage of the scheme may be that they do not
have control over the level taxation and do not enjoy the flexibility of varying the rates of taxation
to suit their needs as they could have done had the taxes been in their own legislative domain.

Article 271 provides for levy of surcharge on certain duties and taxes for purposes of the Union.
Notwithstanding anything in Articles 269 and 270, the Parliament may at any time increase any of
the duties or taxes referred in those articles by a surcharge for purposes of the Union and the whole
proceeds of any such surcharge shall form part the Consolidated Fund of India. 23

Article 271 provides for Union Surcharge. To counter balance the losses to the Union by reason of
assignments mentioned in Articles 269 and 270, the Union is empowered to levy a surcharge on any
of those taxes and appropriate the whole of the proceeds of such surcharge. Surcharge is being
levied on income-tax under this provision.

23
Dr. D. Ananda, “Goods and services tax and its implications for fiscal federalism in India”, 6 International
Journal of Political Science and Governance 2024

14
The expression “surcharge” in the context of taxation means an additional imposition which results
in enhancement of the tax and nature of the additional imposition is the same as the tax on which it
is impose as surcharge. 24 Surcharge stands for an additional or extra-charge or payment. Surcharge
is thus a super-added charge, a charge over and above the usual or current dues.25

The legislative history of the Finance Acts, as also the practice, would appear to indicate that the
term “income tax” includes surcharge as also the special and additional surcharge wherever
provided which are also surcharges within the meaning of Article 271 of the Constitution. The
phraseology employed in the Finance Acts of 1940 and 1941 showed that only the rates of income-
tax and super-tax were to be increased by a surcharge for the purpose of the Central Government. In
the Finance Act of 1958, the language used showed that income tax which was to be charged was to
be increased by a surcharge for the purpose of the Union. The word “surcharge” has thus been used
to either increase the rates of income tax and super tax or to increase those taxes. The scheme of the
Finance Act of 1971 appears to have no room for doubt that the term “income tax” includes
“surcharge”26

In Vishwesha Thirtha Swamiyar v. State of Mysore,27 the Supreme Court observed that it was a
common practice of Indian Legislation to impose surcharges on existing taxes and this article
conferred on Parliament the power to increase taxes or dues by levying a surcharge for the purposes
of the Union.

Additional surcharge is leviable exclusively for the purposes of the Union so that the entire
proceeds of such surcharge may, under Article 271, form part of the Consolidated Fund of India.
Taxes and Duties mentioned in Article 269 (1) though levied and collected by the Government, have
to be assigned to the States in the manner provided in clause (2) of this article. The additional
surcharge levied for the purpose of the Union is to be calculated not on the total income like income
tax, but it is to be calculated in the residential income28 and being a distinct charge, it is not
dependent for its leviability n the assessee’s liability to pay income tax.

The power to levy a surcharge on income tax is traceable to Article 271 read with Entry 82 of List I
of the Seventh Schedule and is not traceable to s. 4 of the Income Tax Act. Every year the Finance
Act is enacted by Parliament to give effect to the financial proposals of the Central Government.
The rate at which a charge on the total income of the previous year is imposed under s.4 (1) of the
24
Surcharge Tea Co. (P.) Ltd. V. Collector of Dibrugarh, AIR 1992 SC 1264
25
Indian Aluminium Co. v. State of Kerala, AIR 1996 SC 1431
26
CIT v. K. Srinivasan, AIR 1972 SC 491
27
AIR 1971 SC 2377
28
Madurai Dt. Central Co-op. Bank Ltd. V. III I. T. O., AIR 1975 SC 2016

15
Income Tax Act is to be fixed by the Central Act. It is because of that, the income tax is levied at
different rates under the Finance Act.29 Article 271, in short, is an exception to Articles 269 and 270
and enables the Union Parliament to enhance the revenues of the Union by levying a surcharge on
those taxes, e.g., estate duties or income tax, without having any obligation to give any part of the
proceeds of such surcharges to the States.

It is therefore, natural for the States to resent against this provision, and they have urged their
contention before successive Finance Commissions, but the situation cannot be rectified without
undertaking an amendment of Articles 270 and 271 which says that the ‘whole proceeds of any such
surcharge’ shall go to the Union. Again, though there is sense in the State’s connection that Article
271 authorized only a temporary30 increase of the relevant taxes occasionally and not as a
permanent feature, the language of article 271 is not clear enough to support this contention. The
expression “at any time” indicates that Parliament is empowered to levy a surcharge from time to
time and merely because Parliament has impose surcharge in one shape, it is not precluded from
imposing a surcharge in another shape to cope with varying circumstances during the subsistence of
the previous one31 and from the language used in the article, it clearly follows that the power is
available to be exercised at any time, which means it can be exercised from time to time.

In the report of the National Commission to Review the Working of the Constitution submitted on
31-3-2002, it is stated thus:

"The Constitution was amended to provide a prescribed percentage of the revenue receipts to be
transferred to the States (Art. 270 (2)). However surcharges and cess do not form part of the
divisible pool. Cess are intended for specific purposes and the States can have no complaint if the
money is spent on pre-determined purposes. Surcharges can be regarded as a not so thinly veiled
device to deny the States their share in receipts from such surcharges. Keeping in view the
complexity of the present national and international situation which has placed additional burden on
the Union, the Commission would "not" recommend any constitutional amendment to make
surcharge sharable, but would expect public policy to move decisively in the direction of doing
away with the surcharges as part of the Union fiscal armoury". 32

Article 275 deals with grants from the Union to certain States. While Art. 273 makes provision for
grants-in-aid for augmenting the revenue of certain States producing jute, this article makes

29
CIT v. Suresh N. Gupta, (2008) 4 SCC 362
30
Cf. Rep. of the 4th Finance Commission (1965) para 34
31
Ved Vyas v. I. T. O., AIR 1955 All 37
32
Report of the NCRWC, Chapter VII – para 4

16
provision for grants-in-aid out of the Consolidated Fund of India to be made under the
Parliamentary legislation for the benefit of the States which may be in need of such assistance.
Clause (1) contains a general provision and grants-in-aid are to be made each year to such States as
Parliament may determine by law, to be in need of assistance. "Grants-in-aid" apart from general
purposes could also be made for meeting the costs of schemes of development undertaken by the
States with the approval of the Union Government for promoting the welfare of the Scheduled
Tribes or the raising of the level of the administration of Scheduled Areas. So far as the State of
Assam is concerned, a special provision has been made.

These grants are given not to each State, but only to such States as may be in need of assistance.
The amount of money payable to the State by way of fiscal need grants is also unconditional and the
recipient State can use the money as they like. These grants are made on the basis of the
recommendation of the Finance Commission.

Article 275 along with Art. 244 and the Sixth Schedule contains certain specific provisions
regarding the governance of tribal areas in Assam and certain other States. 33 The proviso to Art. 275
is one of the provisions under the Scheme of the Constitution which aims exploitation of tribal
people at the protection, advancement and prevention of exploitation of tribal people. 34

Article 275 Clause (1) provides for Grants-in-aid. Parliament is given power to make such grants as
it may deem necessary to give financial assistance to any State which is in need of such assistance.
Discrimination in the matter of making grants would not be unconstitutional, for grants to
financially weak States cannot but discriminatory in nature.

These grants are fixed by Parliament every five years on the basis of recommendation of the
Finance Commisiion. These grants are given not to each State, but only to such States as may be in
need of assistance. The amount of money payable to the States by way of fiscal need grants is also
unconditional and the recipicent States can use this money as they like.

By means of the grants envisaged by the present Article, the Union would be in a position to correct
inter-State disparities in financial resources which are not conducive to an all-round development of
the country and also to exercise control and co-ordination over the welfare schemes of the State on
a national scale.

33
State of Assam v. K. B. Kurkalong, AIR 1972 SC 223
34
Lingappa Pochanna Appealwar v. State of Maharashtra, AIR 1985 SC 389

17
As has been shown by the survey under Article 274, ante, Federal grants-in-aid to the States has
been necessary in all Federal countries, for the simple reason that no system of distribution of
financial resources between the Federation and the Units can possibly meet the need for natural
development and social services which are usually the responsibility of the Units. While the more
productive sources have to be kept in the hands of the Federation to provide for the prime
contingency of defence and national development, the resources of the Units are augmented by
grants made by the Federation according to the varying needs of the States.

A grant-in-aid may be made in different forms.

I. A grant-in-aid is -aid is general, when the grant does not specify the purpose it is to be
appropriated; for which 'specific when the granting authority earmarks the gram it is for a specific
purpose, e.g., education, highways, unemployment relief, for which the money is to be spent.

Under our Constitution, while the general power of making grants for rendering financial assistance
is left to Parliament by cl. (1) of Art. 275, the Constitution itself provides for specific grants on two
matters: (a) The first Proviso provides for payment from the Consolidated Fund of India (without
vote in Parliament) of sums necessary for schemes of development, for the welfare of Scheduled
Tribes and for raising the level of administration of Scheduled Areas, as may have been undertakes
by a State with the approval of the Government of India. (b) The second Provise makes provision
for similar payments to the State of Assam, for the development of the tribal Areas in that State. (c)
Clause (IA), inserted in 1969, provided for the adjustments that became necessary in the matter of
application of the new Proviso to Art. 275, when the autonomous State of Meghalaya was created
out of the State of Assam, by introducing Art. 244A, by the Constitution (22nd Amendment) Act.
1969.

II. A grant may be either obligatory or discretionary.

18
 PART 4

RECENT REFORMS IN FISCAL FEDERALISM IN INDIA AND THEIR IMPACT

Fiscal federalism in India has undergone several reforms in recent years aimed at strengthening the
relationship between the Union government and State governments. These reforms are designed to
streamline the allocation of resources, improve governance, and allow for more localized, efficient
decision-making. While these reforms have provided the States with greater autonomy, they have
also brought with them new challenges, particularly in terms of balancing the interests of the central
government with those of the States and local bodies. There is a need to examine the recent reforms
in India's fiscal federalism, focusing on the Goods and Services Tax (GST), the creation of NITI
Aayog, the reduction of Centrally Sponsored Schemes (CSSs), and the provision for borrowing
under Official Development Assistance (ODA). Additionally, we will discuss the impact of these
reforms on the fiscal autonomy of the States and local governments.

1. Goods and Services Tax (GST)

The introduction of the Goods and Services Tax (GST) on July 1, 2017, marked a significant
turning point in India's fiscal federalism. GST aimed to streamline the country's complex indirect
tax system by subsuming various state and central taxes, such as excise tax, service tax, sales tax,
and octroi, into a single tax regime. The primary objective of GST was to create a unified national
market by eliminating inter-state tax barriers, reducing cascading taxes, and making the taxation
process more transparent.35

GST is designed as a dual tax structure with three components: Central Goods and Services Tax
(CGST), State Goods and Services Tax (SGST), and the Inter-State Goods and Services Tax (IGST).
The CGST and SGST are collected by the Union and State governments, respectively, for intra-state
transactions, while IGST is levied on inter-state transactions. This division of tax authority between
the Union and States theoretically strengthens cooperative federalism, but it also places certain
constraints on the fiscal autonomy of States.

While the GST system simplifies tax collection and improves the ease of doing business, it has
raised concerns about the States' financial autonomy. The GST Council, which determines tax rates
and resolves issues arising from the implementation of the tax, is dominated by the Union
government. States, while represented in the GST Council, have limited influence over key

35
Arindam Shit, “Distribution of Taxes and Grants between the Center, State and Local Governments in India: A
study of India’s Fiscal Federalism”, 7 Journal of Constitutional Law and Jurisprudence 2024

19
decisions, such as the setting of tax rates and the overall structure of the system. This centralization
of fiscal power is seen as a challenge to the States' autonomy in managing their own revenue
sources. Additionally, the compensation provided to States for the loss of revenue due to the
implementation of GST was initially set for five years, but questions remain about the sustainability
of such compensation mechanisms.

Furthermore, the States' fiscal autonomy is also affected by the fact that a significant portion of the
GST revenue is shared between the Centre and the States. The States' reliance on the Centre for
compensation and their inability to influence tax rates raises concerns about the potential erosion of
their financial independence.

2. NITI Aayog

The establishment of the National Institution for Transforming India (NITI Aayog) in January 2015
marked the replacement of the Planning Commission. NITI Aayog is a key policy think tank and
advisory body that formulates strategies and recommends policies to the Union government. It has
been given the responsibility of coordinating and facilitating cooperative federalism through a more
decentralized approach to planning and resource allocation.36

Unlike the Planning Commission, which was often criticized for its centralized approach to resource
allocation and planning, NITI Aayog emphasizes bottom-up planning, with States having a more
significant role in the development process. The creation of NITI Aayog aimed to foster cooperative
federalism by creating a platform for States to engage with the Union government and to shape
national policies according to their needs and priorities. The agency provides a forum for
discussion, collaboration, and the formulation of action plans that align with the goals of the Union
Budget.

Under NITI Aayog's framework, the traditional Five-Year Plans have been replaced with a three-
year action plan that is integrated into a seven-year strategy and a 15-year vision document. These
documents aim to provide a more flexible, adaptable, and long-term approach to planning, focusing
on the specific needs of States while ensuring alignment with national goals. NITI Aayog’s role in
decentralized decision-making and resource allocation has helped States secure more equitable
representation in policy matters.

36
V. Hans, “NITI Aayog”, available at [Link] (last
visited on Jan 05, 2025)

20
However, despite these reforms, NITI Aayog's role in fiscal federalism has its limitations. While
States are given a voice in policy discussions, the centralization of financial control over certain
aspects, such as the control of fiscal resources and the coordination of key projects, still leaves the
Union government with substantial power. This structure, though designed to be more inclusive,
still places considerable constraints on the true financial autonomy of States.

3. Reduction of Centrally Sponsored Schemes (CSSs)

Another important reform in India's fiscal federalism is the reduction in the number of Centrally
Sponsored Schemes (CSSs). Prior to the fiscal year 2016-17, the Union government controlled over
66 CSSs, which often resulted in inefficiency and a lack of flexibility for States in terms of program
implementation. Many of these schemes were poorly coordinated, leading to duplication and
unnecessary complexity in governance.

The reduction of CSSs, which was cut down to 28 schemes, has been a major step towards
decentralizing the implementation of government programs. Under the new framework, the Union
government provides fewer, more streamlined schemes, while empowering States to design and
implement programs tailored to their specific needs. The central government, while still providing
financial support, allows States more autonomy in terms of allocation and execution, encouraging
States to take ownership of their development priorities.37

This restructuring of CSSs is seen as a step in the right direction towards fiscal federalism. By
giving States the flexibility to design schemes suited to their specific needs and challenges, the
reform aims to improve governance at the local level and enhance the overall efficiency of public
spending. It has also reduced the overlap between different government programs and minimized
the financial burden on the States, enabling them to allocate resources more effectively.

However, this reform has also faced criticism for the lack of clear guidelines and support from the
Union government in some cases. While States are given more autonomy, there have been instances
where the design of the schemes has led to inefficiencies, and the States have struggled with limited
financial resources and administrative capacity. This highlights the need for continued support and
capacity-building for the States to make full use of their increased autonomy.

37
Ritwika Sharma, “Fiscal Federalism and Centrally Sponsored Schemes: Rethinking Article 282 of the
Constitution”, available at [Link]
schemes-rethinking-article-282-of-the-constitution/ (last visited on Jan 05, 2025)

21
4. Official Development Assistance (ODA)

The introduction of the Official Development Assistance (ODA) policy in 2017 has allowed States
to borrow from bilateral foreign sources for infrastructure development. This reform is intended to
empower States to undertake large-scale infrastructure projects and welfare schemes without solely
depending on Union government grants or internal revenue sources. The ODA mechanism allows
State government entities to directly access funds from external bilateral agencies, subject to certain
conditions, for purposes such as urban development, education, and healthcare.

The ODA provision has had a positive impact on the fiscal autonomy of States, as it provides them
with an additional source of funding for development projects. It reduces the pressure on the State
governments to rely on Union government support or to raise domestic revenues through taxes and
borrowing. This increased access to external funding can help States address critical infrastructure
gaps and boost public spending on welfare programs.

However, the introduction of ODA also raises concerns regarding the long-term sustainability of
such borrowing. States must carefully manage the repayment of foreign loans, especially in an
environment where fiscal discipline remains a challenge. While the ability to borrow externally can
provide much-needed resources, it also adds to the financial liabilities of States, which could
become problematic if not managed prudently.

5. Fiscal Autonomy and Challenges for Local Governments

Despite the progress made in empowering State governments, local governments continue to face
challenges in terms of fiscal autonomy. While States have gained more control over financial
matters, local governments—particularly in rural areas—remain heavily dependent on central
transfers and grants. Local bodies are often constrained by insufficient revenue-raising powers,
limited fiscal space, and weak administrative capacities.

The reforms introduced in recent years have primarily focused on strengthening the financial
autonomy of States, but they have done little to address the fiscal challenges faced by local
governments. Local bodies still struggle with insufficient resources to deliver essential services such
as healthcare, education, and sanitation, and their dependence on transfers from the Union or State
governments remains high.

To address this gap, further reforms are needed to empower local governments with greater fiscal
autonomy. This may involve devolving more powers to local bodies, providing them with the
authority to raise local taxes, and improving their access to external funding sources.

22
The recent reforms in fiscal federalism in India, such as the introduction of GST, the creation of
NITI Aayog, the reduction of Centrally Sponsored Schemes, and the provision for borrowing under
Official Development Assistance, have had a significant impact on the fiscal landscape. These
reforms have empowered State governments by giving them more control over financial matters
and allowing them to design programs that suit their unique needs. However, challenges remain,
particularly in terms of balancing the financial autonomy of the States with the centralizing
tendencies of the Union government. Furthermore, local governments continue to face constraints in
terms of financial autonomy, which limits their ability to deliver services effectively.

While the reforms have strengthened fiscal federalism to some extent, there is still much work to be
done to ensure that all levels of government—Union, State, and local—have the financial capacity
and autonomy to address the needs of India's diverse population.

23
 PART 5

NEED OF RETHINKING INDIA’S FISCAL FEDERALISM

India's fiscal federalism has long been a topic of considerable debate and discussion, particularly as
the country undergoes rapid economic and political transformations. The evolving dynamics of
fiscal federalism, from the centralized control of the post-Independence era to a more market-
oriented and decentralized system, are marked by a multitude of shifts in policy, governance, and
financial autonomy. These shifts are driven by both economic factors such as the transition from a
planned economy to a market-mediated system and political changes such as the rise of a multi-
party system and the introduction of new reforms. Despite the reforms that have been implemented,
India’s fiscal federalism still requires significant rethinking, especially in terms of balancing
autonomy and cooperation between the Union, State, and local governments.

There is a need to explore several key aspects of India’s fiscal federalism that need to be
reexamined in light of changing economic, political, and institutional factors. These include the
shift from a planned economy to a market-mediated economic system, the 73rd and 74th
Constitutional Amendments, the abolition of the Planning Commission and the creation of NITI
Aayog, the Fiscal Responsibility and Budget Management (FRBM) Act, the introduction of Goods
and Services Tax (GST), and the use of cesses and surcharges.

1. Shift from Planned Economy to Market-Mediated System

The transition from a planned economy to a market-mediated system in India has had profound
implications on the structure and functioning of fiscal federalism. In the era of the planned
economy, India followed a model of centralized economic planning where the state played a
dominant role in allocating resources, determining investment priorities, and regulating key
industries. The Planning Commission, which was set up in 1950, oversaw the distribution of
resources to States for implementing national development plans. The fiscal strategy was
characterized by centralized decision-making and top-down implementation, with little room for
State governments to influence the overall policy direction.

However, with the economic reforms of 1991, India began shifting towards a market-driven
economy. These reforms led to liberalization, deregulation, and privatization, with the goal of
reducing the role of the state in economic activities and allowing market forces to drive growth. The
move to a market-mediated system has led to a greater emphasis on decentralization, giving States a
larger role in determining their economic destiny. In a decentralized system, State governments

24
have more autonomy to make decisions regarding local economic development, tax policies, and
resource allocation.

While this shift has provided States with more freedom to implement their policies, it has also led to
new challenges. The Union government continues to wield considerable influence over fiscal
matters, especially with regards to taxes and central transfers. This tension between autonomy and
centralization creates an ongoing dilemma for India’s fiscal federalism, as States seek more control
over their financial resources while balancing national interests and policies.

2. 73rd and 74th Constitutional Amendments: Empowering Local Governance

The 73rd and 74th Constitutional Amendments, passed in 1992, were monumental in decentralizing
governance and empowering local bodies. These amendments provided a constitutional basis for the
establishment of Panchayats at the rural level (73rd Amendment) and Municipalities at the urban
level (74th Amendment). The aim was to bring government closer to the people and improve local
governance by promoting decentralization and democratic participation.

Despite the intent to empower local bodies, the amendments have not been fully effective in
ensuring financial autonomy for Panchayats and Municipalities. One of the critical issues is the
inadequate and unpredictable transfer of funds from state governments to local bodies. Although the
Constitution mandates the devolution of resources to local governments, in practice, the state
governments often exercise discretion over these transfers, delaying or withholding funds as they
see fit. This discretionary power undermines the autonomy of local bodies and restricts their
capacity to implement development policies effectively. The lack of guaranteed funding and the
inconsistent flow of resources make it difficult for local governments to fulfill their responsibilities,
hindering the intended decentralization of power.

This problem is compounded by the absence of a transparent and robust system for monitoring the
allocation and use of funds at the local level. Local governments often lack the administrative
capacity to manage finances effectively, leading to inefficiencies in the delivery of public services.
Therefore, there is a need for a comprehensive fiscal decentralization framework that ensures
predictable and adequate transfers to local bodies, along with the necessary capacity-building
measures.38

38
Supra note 35

25
3. Abolition of Planning Commission and Introduction of NITI Aayog

The abolition of the Planning Commission in 2015 and its replacement by the National Institution
for Transforming India (NITI Aayog) marked a significant shift in the governance and planning
structure of India. The Planning Commission had been central to India’s economic planning since
its inception, with considerable influence over resource allocation and the design of development
programs. However, the Planning Commission was often criticized for its top-down approach and
its limited focus on states’ diverse needs and aspirations.

NITI Aayog was created as a policy think tank with the goal of fostering cooperative federalism,
encouraging states to design and implement their own development strategies. Unlike the Planning
Commission, NITI Aayog does not have direct control over financial resources or central-state
transfers. Instead, it provides strategic advice and technical support to the Union and State
governments. NITI Aayog’s role is more collaborative, aimed at promoting policy dialogue between
the center and the states, and ensuring that state-specific needs are incorporated into national
policies.

However, the absence of direct control over central-state fiscal transfers means that NITI Aayog has
limited power to address disparities between States. While it has been successful in promoting the
idea of cooperative federalism, its effectiveness in influencing financial outcomes for States remains
constrained. As a result, fiscal federalism in India remains heavily influenced by the central
government’s control over financial resources, limiting the true autonomy of States.

4. Fiscal Responsibility and Budget Management (FRBM) Act, 2003

The Fiscal Responsibility and Budget Management (FRBM) Act, passed in 2003, aimed to bring
greater fiscal discipline to both the central and state governments by setting targets for reducing
fiscal deficits and managing public debt. The FRBM Act was introduced to ensure that government
borrowing and expenditure remain sustainable in the long term, thus fostering fiscal stability and
macroeconomic health.39

While the FRBM Act has been successful in promoting fiscal discipline, it has also created certain
tensions in the context of fiscal federalism. For example, the act imposes limits on state borrowing
and borrowing from markets, which restricts the ability of State governments to finance large-scale
infrastructure projects and welfare schemes. Furthermore, the central government’s fiscal targets
have sometimes conflicted with the need for States to invest in growth and development. Balancing

39
Supra note 35

26
fiscal prudence with the need for growth-oriented spending remains a challenge under the FRBM
framework, and States often feel constrained by the limits imposed on them.

Moreover, the implementation of the FRBM Act has sometimes led to the centralization of fiscal
decision-making, with the Union government exerting greater control over state fiscal policies. This
centralization, while intended to ensure national fiscal stability, limits the States' capacity to make
independent fiscal decisions based on local needs.

5. Goods and Services Tax (GST) and the GST Council

The introduction of the Goods and Services Tax (GST) in 2017 was one of the most significant
fiscal reforms in India. GST replaced a complex system of indirect taxes with a unified national tax,
simplifying the tax structure and promoting the ease of doing business. The implementation of GST
led to the creation of the GST Council, which is responsible for setting tax rates and resolving
disputes between the Centre and States.

While GST has simplified the tax system and promoted greater tax compliance, it has also reduced
the tax collection powers of States. The GST Council, which consists of representatives from both
the Union and State governments, has been criticized for being dominated by the Union
government. Several State finance ministers have voiced concerns that the decisions of the GST
Council are often influenced by political considerations rather than economic rationale, and that
States' interests are often outvoted by the Union or other States. This lack of adequate representation
and influence undermines the fiscal autonomy of States.

Additionally, the compensation provided to States for revenue loss due to the introduction of GST
has been a source of controversy. Many States have raised concerns about delayed and inadequate
compensation payments, leading to financial instability in several States. These issues highlight the
need for a more balanced and fair system of fiscal decentralization under GST.40

6. Use of Cesses and Surcharges

The use of cesses and surcharges has become a common practice for the central government to raise
funds for specific purposes. While these additional levies are designed for targeted interventions
(such as health, education, or infrastructure), they also reduce the size of the divisible pool of taxes,
affecting the amount of revenue available for distribution to States. This reduces the fiscal space for
States and impedes their ability to finance their own programs independently.

40
Supra note 35

27
For example, the introduction of the GST compensation cess to compensate States for revenue
losses has led to delays in payments, leaving States in a precarious financial position. Similarly, the
reliance on cesses and surcharges for specific purposes reduces the funds available for general
distribution to States, leading to imbalances in fiscal resource allocation.

7. Central Legislations and Extra Burden on States

Several central legislations, such as the Mahatma Gandhi National Rural Employment Guarantee
Act (MGNREGA), the Right to Education Act (RTE), and the National Food Security Act (NFSA),
impose significant financial burdens on State governments. While these programs aim to promote
social welfare and reduce inequality, they often place additional fiscal responsibilities on States
without adequate financial support. The lack of sufficient central funding for these programs forces
States to divert resources from other essential services, straining their fiscal capacities.

8. Evolved Political Discourse and Fiscal Dynamics

India’s political landscape has evolved dramatically over the years, shifting from a one-party
dominant system to a truly multi-party system. This has created new dynamics in fiscal federalism,
as different States with varied political affiliations and priorities now play a more active role in
shaping fiscal policies. The rise of regional parties has led to a more complex negotiation process
between the Union and States, influencing fiscal transfers, resource allocation, and policymaking.

The evolving political discourse has also introduced new fiscal dimensions. Regional parties often
push for more autonomy and resources for their States, leading to heightened competition between
States for central resources. This increased political competition has changed the nature of fiscal
federalism, making it more dynamic but also more contentious.

India’s fiscal federalism needs to be rethought in light of the many changes in the economic,
political, and institutional landscape. The shift from a planned economy to a market-mediated
system, the introduction of GST, the restructuring of the Planning Commission, and the evolving
political discourse all suggest the need for a more balanced and inclusive approach to fiscal
decentralization. To foster true fiscal autonomy for States and local bodies, there needs to be greater
clarity and transparency in the financial framework, ensuring that resources are allocated efficiently
and equitably. This will require reforming fiscal rules, ensuring more predictable transfers to local
governments, and revising the decision-making processes in institutions like the GST Council. Only
through a comprehensive rethinking of fiscal federalism can India achieve sustainable and inclusive
development across all regions.

28
 PART 6

CONCLUSION

The distribution of fiscal powers between the Centre and the States is a cornerstone of India's
federal structure, laid down by the Constitution. The framers of the Constitution carefully designed
this framework to ensure a balance between central authority and state autonomy, with the
overarching goal of ensuring national unity, equity, and economic development. The Constitutional
provisions, the subsequent reforms, and the evolving political landscape have continuously shaped
and redefined this balance over time. However, as India moves forward into a new era of
governance and economic challenges, there is a need to reconsider and adapt the distribution of
fiscal powers to meet the demands of a rapidly evolving economy, more inclusive development, and
federal cooperation.

The Constitution of India, which came into force in 1950, sets the legal framework for the
distribution of fiscal powers between the Union and the States. Part XII of the Constitution governs
the financial relations between the Centre and the States, specifying the allocation of revenue, the
responsibility for taxation, and the power to borrow. The fundamental structure of fiscal federalism
in India is characterized by a combination of centralization and decentralization, which allows for
both national coherence and regional autonomy. The Constitution divides fiscal powers between the
Centre and States into three lists: the Union List, the State List, and the Concurrent List. The Union
List comprises subjects on which only the Central Government can legislate and levy taxes. The
State List includes subjects on which States have exclusive power to legislate and levy taxes. The
Concurrent List allows both the Centre and the States to legislate, though in the case of conflicting
laws, the law enacted by the Centre prevails.

One of the key features of India’s fiscal federalism is the distribution of revenue powers. The Union
Government has control over a larger pool of taxes, including income tax, customs duties, and
excise taxes. Meanwhile, State Governments have control over taxes such as sales tax, state excise
duties, and stamp duties. The Constitution also provides for the establishment of a Finance
Commission, which is responsible for recommending the distribution of the net proceeds of taxes
between the Centre and the States and ensuring that States have sufficient resources to meet their
responsibilities. This framework is intended to provide a balance between the need for central
coordination and the autonomy of States. While the Union Government has the ability to collect
revenue from various sources, it is obligated to share a portion of this revenue with the States. The

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Finance Commission’s role in ensuring that fiscal transfers from the Centre are equitable and
adequate is critical in maintaining this balance.

Over the years, several reforms have been introduced in India’s fiscal federal structure. These
reforms were designed to address the changing dynamics of the economy, to promote better
coordination between the Centre and the States, and to ensure more efficient resource allocation.
Key reforms include the establishment of the Goods and Services Tax (GST), the abolition of the
Planning Commission, the creation of NITI Aayog, and the reforms related to fiscal responsibility.

One of the most significant recent reforms in fiscal federalism is the introduction of the Goods and
Services Tax (GST) in 2017. Prior to GST, India had a complex system of indirect taxes, including
excise tax, service tax, sales tax, and octroi, which led to inefficiencies in the tax system and created
a barrier to interstate trade. GST, a single tax on the supply of goods and services, was designed to
create a unified tax system that would streamline taxation, reduce tax cascading, and enhance the
ease of doing business. However, the introduction of GST has altered the distribution of fiscal
powers between the Centre and the States. Under the new system, States have ceded control over
many indirect taxes that were previously within their domain. The GST Council, a body comprising
representatives from both the Centre and States, is responsible for deciding tax rates and making
policy decisions. While the introduction of GST has improved tax compliance and transparency,
there have been concerns about the dominance of the Centre in the GST Council’s decision-making
process. Some state governments have argued that they do not have sufficient influence in the
Council and that decisions are often made in a manner that disproportionately benefits the Centre.
Furthermore, the GST Compensation Cess, intended to compensate States for the revenue loss due
to the introduction of GST, has been delayed in some cases, creating financial strain for several
States.

The Planning Commission, established in 1950, was an important institution for central planning
and allocation of resources to States. However, over time, it became increasingly criticized for its
top-down approach, lack of flexibility, and inefficient allocation of resources. In 2015, the Planning
Commission was replaced by the National Institution for Transforming India (NITI Aayog), a policy
think tank with the mandate to promote cooperative federalism, coordinate development efforts, and
facilitate the sharing of knowledge and resources between the Centre and the States. NITI Aayog
has been instrumental in promoting a more consultative and collaborative approach to policy
formulation. However, unlike the Planning Commission, it does not have direct control over central
transfers to the States. The absence of direct authority over fiscal transfers has limited NITI Aayog's

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ability to address disparities between States in terms of resource allocation. While NITI Aayog has
succeeded in fostering dialogue between the Centre and the States, its role in ensuring equitable
fiscal devolution remains constrained.

The Fiscal Responsibility and Budget Management (FRBM) Act, introduced in 2003, aimed to
bring greater fiscal discipline to both the Centre and the States by setting targets for fiscal deficits
and public debt. The Act sought to prevent fiscal indiscipline and ensure long-term fiscal
sustainability. It also imposed limits on borrowing by State Governments, restricting their ability to
independently finance development projects through debt. While the FRBM Act has helped improve
fiscal discipline, it has also created tensions between the Union and the States. State Governments
argue that the Act’s fiscal constraints limit their ability to make growth-oriented investments,
especially in infrastructure and social welfare programs. The centralization of fiscal control through
the FRBM framework has, at times, led to a mismatch between the fiscal realities of States and the
targets imposed by the Centre. Balancing fiscal prudence with the need for regional development
remains an ongoing challenge.

India’s fiscal federalism has evolved over time to meet the changing needs of the country. However,
despite the reforms introduced, there are several reasons why India’s fiscal federalism requires
rethinking. One of the primary concerns in India’s fiscal federalism is the limited fiscal autonomy of
States. The Union Government continues to wield significant control over revenue generation and
expenditure, while States are often dependent on central transfers to meet their fiscal needs. This
imbalance affects the ability of States to prioritize their own development agendas and design
policies suited to local needs. The GST, for instance, has reduced the tax autonomy of States, and
the dominant role of the Union in the GST Council has led to concerns about the representation and
interests of States in decision-making.

State Governments must be given greater fiscal autonomy to address local challenges and design
policies that promote regional development. This could involve giving States more control over
taxes, ensuring equitable distribution of resources, and expanding the scope for borrowing and
public investment. Another key issue is the financial autonomy of local governments. While the
73rd and 74th Constitutional Amendments were intended to decentralize governance and empower
local self-government institutions, local bodies often face delays and uncertainties in receiving
funds from State Governments. The lack of guaranteed, predictable transfers to local governments
reduces their ability to implement development programs effectively. A more robust framework for

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fiscal devolution to local bodies, coupled with capacity-building measures, is essential for ensuring
that decentralization translates into tangible benefits for communities at the grassroots level.

India is a highly diverse country, with significant regional disparities in terms of economic
development, infrastructure, and human development indicators. While fiscal transfers from the
Centre to the States are intended to reduce these disparities, the distribution of funds often fails to
address the unique needs of different regions. A more nuanced approach to fiscal transfers, which
takes into account the specific developmental challenges faced by individual States, is needed. This
would ensure that fiscal devolution is not merely an exercise in equal distribution but a means to
foster inclusive growth across the country.

The Finance Commission plays a crucial role in determining the distribution of financial resources
between the Centre and the States. However, the current system often fails to adequately address the
needs of States with specific challenges, such as those with large populations or low per capita
income. The Finance Commission’s approach to fiscal transfers should be revisited to ensure that
resources are allocated in a manner that promotes regional development and reduces inequalities.
Additionally, the Finance Commission should focus on promoting greater transparency and
accountability in the allocation and utilization of funds.

Finally, ensuring greater cooperation between the Centre and the States is critical for the effective
functioning of India’s fiscal federalism. NITI Aayog’s role in promoting cooperative federalism
must be expanded to ensure that States are not only consulted but also actively involved in the
decision-making process, especially in areas such as tax policy and resource allocation. A more
collaborative and less confrontational approach to fiscal governance will help foster national unity
and ensure that all regions of India have the resources and autonomy needed for their development.

In conclusion, the distribution of fiscal powers between the Centre and the States in India is a
dynamic and evolving aspect of the country's federal structure. The Constitutional framework has
laid the foundation for a balanced allocation of fiscal authority, but recent reforms, such as the
introduction of GST, the creation of NITI Aayog, and the implementation of the FRBM Act, have
altered the balance between the Centre and the States. While these reforms have contributed to
greater efficiency and coordination, challenges remain in ensuring equitable resource allocation,
enhancing state autonomy, and addressing regional disparities. There is a pressing need to rethink
India’s fiscal federalism to address the changing economic and political landscape. This rethinking
should involve granting greater fiscal autonomy to States, ensuring predictable and equitable
financial transfers to local bodies, addressing regional disparities, and promoting cooperative

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federalism. Only through such a comprehensive and inclusive approach can India’s fiscal federalism
evolve to meet the needs of a diverse and dynamic nation, fostering inclusive growth and
development across all regions.

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 BIBLIOGRAPHY

I. BOOKS
1. M. P. Jain, Indian Constitutional Law (Lexis Nexis, Haryana, 8th edn., 2018)
2. V. N. Shukla, Constitution Of India (Eastern Book Company, Lucknow, 12th edn., 2013)
3. DURGA DAS BASU INTRODUCTION TO THE CONSTITUTION OF INDIA 369
(22nd ed.).
4. B. P. R. Vithal and M. L. Sastry, Fiscal Federalism In India, (Oxford University Press,
Michigan, 2001)
5. VII, Constituent Assembly Debates
II. Acts
1. The Constitution Of India, 1950
III. JOURNALS/ARTICLES
1. Mr. Richard Hemming, “Fiscal Federalism in Theory and Practice” available at
[Link]
2. O. C. Sud, “Fiscal Ambiguities Between Centre And States”, 74 The Indian Journal of
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3. Ms. Palak Jagtiani, “Fiscal and Cooperative Federalism Under The Indian
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4. Gauthaman V, “Preserving Fiscal Autonomy In The Indian Social Policy Landscape:
Addressing Centralization And Inter-Governmental Structures”, 8 NUJS Journal of
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5. Dr. D. Ananda, “Goods and services tax and its implications for fiscal federalism in
India”, 6 International Journal of Political Science and Governance 2024
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Governments in India: A study of India’s Fiscal Federalism”, 7 Journal of Constitutional
Law and Jurisprudence 2024
7. V. Hans, “NITI Aayog”, available at
[Link]
8. Ritwika Sharma, “Fiscal Federalism and Centrally Sponsored Schemes: Rethinking
Article 282 of the Constitution”, available at [Link]
federalism-and-centrally-sponsored-schemes-rethinking-article-282-of-the-constitution/
IV. JUDICIAL DECISIONS
1. Bar Council v. State of UP, AIR 1973 SC 231

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2. In re Rupendra Pershad Saigal, AIR 1958 AP 63
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11. CIT v. Suresh N. Gupta, (2008) 4 SCC 362
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13. State of Assam v. K. B. Kurkalong, AIR 1972 SC 223
14. Lingappa Pochanna Appealwar v. State of Maharashtra, AIR 1985 SC 389

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