Concept of Fiscal Federalism
The term Fiscal federalism can be defined as the division of functions of the government and the financial relationship between different levels of the government, basically how federal or central governments to fund state and local governments. In other words, fiscal federalism in India refers to the division of responsibilities with regards to public expenditure and taxation between the different levels of the government in India. In this article, you will be able to know the fiscal federalism and resource allocation between Centre and State under the Constitution of India.
Richard Musgrave in 1959 first developed the theory of fiscal federalism. Musgrave argued that federal government system has the ability to solve many of the issues local governments face by providing the balance and stability needed to overcome disruptive issues like uneven distribution of wealth and lack of widely available resources. Musgrave further theorized that federal governments should manage a nation’s money from the top and given to states, who can distribute it locally as needed.
The constitutional fiscal arrangement shows the fiscal imbalances were deemed inevitable as most of the powers for elastic taxes are given to the central government. Further, the division of powers and functions it-self leads to vertical federal fiscal imbalances while the differences in the endowment position of the natural resources across states cause horizontal federal fiscal imbalances. Visualising the fiscal imbalances, the constitutional makers provided a mechanism of fiscal adjustment by way of fiscal transfers from the centre to state governments. Article 280 of the Indian constitution make provision for the finance commission by the President of India. It was formed to define the financial relations between the central government of India and individual state governments. Finance commission appointed by the central government for every five years.
The borrowing powers have also been clearly mentioned in the constitutions. Under article 292, the central government is empowered to borrow funds from within and outside the country as per the limits imposed by the parliament. According to article 293, the state can borrow funds within the country, and the central government provide a loan if needed.
Resource Allocation between Centre and State under the Constitution of India
India is a federal country, so there is a division of both powers and responsibilities between the central government and state government. The financial system of India is federal in nature. The fiscal federalism in India is according to constitutional provision and the constitution of India has made a clear division of fiscal powers between the union and the states. The principle is that the division of power is such that the sources of revenue assigned to the centre and the states should be adequate to enable them to fulfil the functions allocated to them and each state should have independent financial authority. There are also some provisions to distribute the powers between the state and the local government bodies to make the system more flexible and decentralised.
In India, the major source of revenue generation for government expenditure is the tax collection. Tax is collected by both the central and the state government according to the rules mentioned in the constitution of India. The objective of the constitution is to prevent overlapping tax powers, which translate into a requirement that one type of tax is levied only by one level of government. According to fiscal federalism in India, the central government is assigned the most important taxes with economy-wide implications i.e. taxes which have an inter-state base are levied by the union while those taxes, which have a local base, are levied by the States. While the Union Government levies some taxes for its exclusive use and it has also the power to impose taxes, which are not specifically mentioned in the state or concurrent list. Similarly, functions have also been divided between the Centre and the States.
Financial provisions are embodied in Part XII of the constitution of India (From Article 264 to Article 300). The Seventh Schedule of the Constitution of India divides functions and financial resources between the Centre and the States. It contains three lists:-
- List I: Union List- The Union list has 97 subjects on which it has the power to make laws under the supervision of the parliament. Some of the subjects are defence, railways, airways, telecommunication, heavy industries, external affairs, banks, regulation of inter-state rivers etc.
- List II: State List- The state list contains 66 subjects considering its conditions and needs like irrigation, education, public health, rural development, roads, agriculture, intoxicating liquors, land revenue etc.
- List III: Concurrent list- The provision of concurrent List is made because there are certain matters, which cannot be allocated exclusively to the Union or State legislature. The subjects included under the list are population and family planning, criminal law and procedure, economic and social planning, labour and welfare, maintenance of public order, books, printing press etc.
Taxes Levied by The Central Government and The State Government
List I: Union list
- The central government collects revenue from different tax and non-tax revenue.
The union list consists of 97 entries and contains the following sources of tax revenue for the central government.
- Income tax other than income tax on agricultural income
- Custom duties including export duties
- Excise duties on tobacco and other goods manufactured or produced in India including the use of alcohol or any other like substance for medicinal purpose or for toilet preparations
- Corporation tax
- Taxes on capital value except agricultural land
- Estate duty
- Terminal taxes
- Taxes on transactions in stock exchanges and future markets except stamp duties
- Taxes on newspapers and advertisements in it
- Taxes on the sale and purchase of goods under inter- state trade or commerce
- Non-tax revenue
- Fees in respect of any of the matters in the list, but not including fees
taken in any court.
- Fees taken in Supreme Court
- Borrowings both internal and external
- Income from Government Undertaking and Monopolies.
- Incidental receipts: – Income accruing to the Government of India on
account of the exercise of various Government functions and rights.
List II: State list
List II of the Seventh Schedule covers the function and the financial resources of the States with 66 entries.
- Land revenue
- Taxes on agricultural income
- Successions duties and Estate duty with respect to agricultural land
- Excise duties on alcoholic liquors and narcotic drugs and narcotics used for human consumption
- Taxes on land and buildings
- Taxes on minerals rights
- Taxes on the entry and sale of goods into a local area for consumption
- Taxes on the consumption and sale of electricity.
- Taxes on the sale and purchase of goods other than newspapers excluding inter-state sale.
- Taxes on advertisements except in newspapers
- Transportation tax on roadways and inland waterways
- Taxes on luxuries
- Toll tax
- Capitation tax
- Non-tax revenue
- Fees in respect of any of the matters in the States List
- Fees in all courts except Supreme Court.
- The State Government are authorised to borrow against the security of their respective Consolidated Funds, but only within the country, including loans from the Government of India.
- Income from partly or wholly state government undertakings
- Royalty from mines, forests, treasure, travel etc.
- Grant-in-aid and other grants from central government.
List III: Concurrent list
There are no tax powers in a Concurrent List or under the joint authority of the Union and the States.
Tax sharing between the union and the state government is divided into five categories
- Taxes levied, collected and wholly retained by the Union Government except for income tax, union excise duties.
- Taxes levied and collected by the Union but are wholly assigned to the States mentioned under Article 269 of the Indian Constitution.
- Taxes levied and collected by the Union Government but may be shared with the States either on a mandatory or permissible basis.
- Taxes levied by the Union but collected and retained by the States like stamp duty.
- Taxes levied, collected and retained by the States like taxes on agricultural income, land revenue, tax on land and buildings, excise duties etc.
The powers which are not mentioned in any of the three lists have been vested with the centre or Parliament and are known as the residuary powers.
Based on the above discussion, it can be understood that the fiscal federalism in India and resource allocation between the centre and state governments is as per constitutionally provisioned and is specified for both.
Author: Juhi Singh Department of Economic Studies and Policy Central University of South Bihar
Author: Raviranjan Kumar Department of Economic Studies and Policy Central University of South Bihar
Author: Alok Aditya Department of Economic Studies and Policy Central University of South Bihar