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Subject ECONOMICS

Paper No and Title 8: Economic Planning in India: Overview and Challenges

Module No and Title 31: Fiscal Federalism

Module Tag ECO_P8_M31

ECONOMICS Paper No. 8: Economic Planning In India: Overview And

Challenges
Module No. 31: Fiscal Federalism
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Table of Contents
1. Learning Outcomes
2. Introduction
3. Nature of Fiscal Federalism
3.1 Relation between Centre and States
3.2 Cooperative and Organic Federalism
3.3 Role of Constitution
4. Recent issues in Indian Fiscal Federalism
5. Summary

ECONOMICS Paper No. 8: Economic Planning In India: Overview And

Challenges
Module No. 31: Fiscal Federalism
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1. Learning Outcomes
After studying this module, you shall be able to

 Know about how the Indian fiscal federation operates

 Understand the nature of fiscal federalism
 Assess the various relations between Centre and States
 Analyse the role of constitution in federalism
 Assess the recent issues in Indian fiscal federalism

2. Introduction
The word ‘Federalism’ originates from the Latin word “foedus” which means ‘treaty’ or
‘covenant’. A Federal State is one where some free states are bound together by an agreement.
Federalism allows a system of government of a country to emerge where a central or Union
government and several state governments coexist, as contrasted with a unitary state. Under this
system, power is allocated between the central and state governments, such that each has
authority in their independent spheres but maintain cooperation and coordination in favor of the
nation.

As per Oates, the purpose of fiscal federalism is to allocate functions and instruments that should
best be centralized and which are mostly suitable for decentralized stages of govt. Fiscal
Federalism is described as a study of how expenditure competencies and revenue fiscal
instruments are distributed across different levels of administration. It also allows for an
understanding of evolving a system of grants and sharing of revenues central government and
states governments.

Fiscal federalism creates a normative framework for assigning roles to the various forms of govt.
and allows for creation of fiscal instruments to implement fiscal functions.

3. Nature of Fiscal Federalism

3.1 Relations between Centre & States

There are three relations that exist between the Centre & States:

Legislative Relations: The Constitution of India splits legislative authority between the Union
and the States in three lists:
 The Union list contains 99 items on which only the Union Parliament has authority to set
laws. Items contained within the list relate to foreign trade, posts & telegraphs, defence,
etc.

ECONOMICS Paper No. 8: Economic Planning In India: Overview And

Challenges
Module No. 31: Fiscal Federalism
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 The State list consists of 61 subjects on which usually

only the States alone can make laws. Items included in the list relate to agriculture,
police, judiciary, administration of local governments, etc.
 The Concurrent list contains 52 items. Items included in the list relate to criminal & civil
procedure, marriage & divorce, economic & special planning, trade unions, electricity,
education, population control etc. Both Union Parliament and State legislatures can form
laws on subjects included in the Concurrent list, but the Centre has a priority to legislate
on current subjects.

In instance of conflict amongst the Union law and law of the State on a subject in the Concurrent
list, Parliament law prevails. Parliament can also legislate on subjects in the State list if the Rajya
Sabha passes a resolution by 2/3rd majority that it is obligatory to do so in the national interest.
Parliament can form laws on subjects in the State List at time of national emergency. Under
Article 356 Parliament can follow the legislative authority of the State, in case of breakdown of
constitutional machinery in the State. Parliament is allowed to legislate on state subjects for the
implementation of international treaties or agreements and on subjects in the State list if 2 or
more states jointly request for it. These provisions allow the Centre to enjoy more extensive
powers than the States.

Administrative relations: The Constitution of India is centered on the principle that the
executive power is co-extensive with legislative power. This infers that the Centre or states can
handle all matters on which Parliament or state legislature can legislate. The executive power
over Concurrent list can be implemented by the states unless the Union government overrules. In
matters of defence, communications, railways, protecting interests of minorities and scheduled
tribes, the Centre can issue directives to the state to adhere to laws made by Parliament. Actually
the Centre usually acquires control over states decisions by contro; exerted through All India
Services, grants-in-aid. Likewise the Parliament alone can adjudicate in inter- state river disputes.
The Union government can assume all the executive powers of the state during emergencies or
failure of constitutional machinery in a state.

Financial Relations: The Constitution of India has provided both the Union government & the
states with autonomous sources of revenue. While Union Parliament can impose taxes on the
subjects contained within the Union list, states can impose taxes on the subjects in the state list.
There aren’t any taxes on the subjects in the Concurrent List. However, the States are greatly
dependent on the Centre for finances to meet their ever increasing developmental expenditures.
The Centre can implement control over state finances through the Comptroller & Auditor General
of India and grants-in-aid. During any financial crisis, the President has the supremacy to append
provisions concerning division of taxes amongst the Centre & the states. Article 280 of the
Constitution, allows for the formation of a Finance Commission by the President one time in
every 5 year for making recommendations about distribution of net earnings of the taxes amongst
the Centre & the states, and principles governing grants-in-aid.

3.2 Cooperative and Organic Federalism

Cooperative Federalism occurs when the Centre and states co-operate through various
instruments to promote the common purpose, instead of fighting for power. India at present is
following Organic Federalism, where everyone functions as a part of one organization to achieve
ECONOMICS Paper No. 8: Economic Planning In India: Overview And
Challenges
Module No. 31: Fiscal Federalism
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the common governmental purposes. The Constitution of India

offers a number of instruments to uphold co-operative federalism. Article 263 enables the
President to create Inter-State Council to encourage better co-ordination between the Centre &
States. Inter-State Council is headed by the Prime Minister & comprises of 6 Cabinet ministers of
the Union & Chief Ministers of all the states & union territories.

To guarantee better cooperation among states on ground of planning & other matters of national
prominence Zonal Councils are made under the State Re-organization Act, 1956. The act
separated the country into 6 zones and offered a Zonal Council in every zone. Every council
involves the Chief Minister & 2 other ministers of each of the states in the zone & the
administrator in stance of the union territory. The Union Home Minister is designated to be the
common chairman of every zonal councils.

However the Indian Federation has been envisioned with a resilient Centre as the framers of the
constitution were sentient that there were widespread economic disparities among several areas of
India because of diversity and its huge size.

3.3 Role of Constitution

A federal system owes its existence to the constitution. All executive, legislature or judicial
powers, whether belonging to the Centre or states, are subordinated to and controlled by the
constitution. Every provision must be defined by a written instrument to be workable and ensure
stability of the system. All constitutional provisions must be binding on the Centre and state
governments. None of the govts must be in a situation to overrule the provisions of the
constitution concerning to the power & status which everyone is to appreciate.
A constitution must also be rigid to be regarded as a supreme law of the land. The procedure of
amendment of constitutional provisions is very complicated and difficult. To maintain legalism of
amendments to the constitution the distribution of powers made by the constitution must be
effectively protected by the judiciary.

The Indian Constitution has some more distinctive features, when compared with other federal
constitutions.
Indian Constitution has no provision for dual citizenship, as there is a dual polity with single
citizenship. All Indians have the same rights of citizenship, no matter in which state he resides, as
there is no independent state citizenship. Unlike USA, in India states are not allowed to have a
separate constitution. There is a common constitution that must be adhered to by Centre and all

ECONOMICS Paper No. 8: Economic Planning In India: Overview And

Challenges
Module No. 31: Fiscal Federalism
____________________________________________________________________________________________________

States.
In normal times, the Indian Constitution effectively works as a federal system, but during wars
and national emergencies can work as a unitary system.

The Indian constitution does not set up the states as rivals to one another or to the centre. All are
expected to work efficiently in their own areas without disturbance by others. However there is
provision of a dominant power of the Centre, if it is crucial in public interest.

4. Recent Issues in Indian Fiscal Federalism

Federalism is a dynamic concept, not static. In a process of evolution certain adjustments are
required to address the contemporary needs. The problems between Centre & states can be settled
by negations and discussions to bring about cooperation.

Given the era of merger governments at the Centre and also in several states, fiscal federalism
assumes a greater significance. However its very essence is getting diluted. There is a
requirement for greater fiscal federalism as:
• central government is finding it difficult to meet the compelling requirements of various
constituencies simultaneously, so they need to build local capacity by giving
responsibilities to state governments;
• central government is dependent on state governments to cooperated with it on
implementing economic development strategies; and
• State governments have been asking for autonomy in functioning and provision of
taxation powers to meet their expenditure responsibility.

The Centre plays an important role in the economy by correcting instances of market failure,
ensuring equitable distribution of income, maintaining macroeconomic stability at full
employment levels and controlling inflation. Market failures need to be corrected by providing
public goods, and as these depend on local inputs and needs these should be under the state
control. So coordination needs to be developed between central and state governments.

Over the years, there have been certain issues with states’ power to utilize available fiscal
instruments on the revenue side, at a time when their expenditure policies are heavily influenced
by central plan and the manner of transfer of Centre’s funds to the states. Moreover by
announcing several Centre sponsored schemes the Centre has systematically eroded fiscal
autonomy of states as state governments are forced to bear a noteworthy share of their costs. As
state governments face increasing burden with their fiscal responsibilities, centrally-sponsored
schemes should be entirely provided for by central government. This will result in state
governments’ willingness to undertake better implementation of such schemes.

On many issues, the Centre should limit itself to policy making and leave implementation to
states as they are in a better position to understand local social welfare needs.
The Centre is bound to collect certain taxes for the states, and must share a substantial portion
with the state governments. But while deciding taxation the Centre does not consult with the
states for all relevant tax related matters. Over time the proportion of plan assistance to states

ECONOMICS Paper No. 8: Economic Planning In India: Overview And

Challenges
Module No. 31: Fiscal Federalism
____________________________________________________________________________________________________

from the Centre has reduced hugely and now is just about 10
percent of total outlays from around 60 percent earlier.

Over time the autonomy of Finance Commission has been affected mainly due to political
understanding between Centre-state fiscal relations. The Centre determines finance commissions
‘terms of reference’ and also interprets their recommendations to suit its own needs.

Finance Commissions are compelled to first determine the requirements of central government
including budgetary support to the Centre’s plan, leaving little for allocating amongst the states.
There have been issues where state governments were denied their legitimate share of revenues
due to political differences with the Centre.

Actually state governments are much more competent than the Centre to undertake provisioning
of most public goods whose needs are local in nature. So they should have commensurate power
to raise revenue, and get a larger share of revenues from the Centre as non-plan expenditure.

5. Summary
 Indian government in India is of a quasi-federal form, as it is both federal and unitary.
 The federal nature allows for the distribution of powers between the Center and States,
and unitary nature allows for retention of Centre’s control over certain State matters.
 There are certain constitutional provisions related to emergencies, such that all powers of
a State can be transferred to the Center.
 For making Indian federalism a viable system, any difference between the centre and the
state need to be settled amicably to allow for successfully meeting the great challenges of
diversity, defence, and socio-economic development.

ECONOMICS Paper No. 8: Economic Planning In India: Overview And

Challenges
Module No. 31: Fiscal Federalism