Centre-State Financial Relations in India: Unraveling the Tension Points

Examine the tension areas in Centre-State financial relations in India. (HPAS Mains Question Paper 2022 – GS 2, Q.16)

The Indian Constitution establishes a framework for Centre-State relations by defining the roles and responsibilities of the central and state governments.

The following are the critical components of Centre-State ties in the Indian Constitution:

Legislative relations: The Indian Constitution provides for a division of legislative powers between the central government and state governments. The Union List contains subjects over which the central government has legislative authority, whereas the State List contains topics over which state governments have legislative power. The Concurrent List includes issues on which federal and state governments can pass legislation, but federal law will take precedence in the event of a conflict.
Administrative relations: The Constitution specifies how executive powers are divided between the federal government and the states. The central government is in charge of issues that affect the entire country, such as defence, foreign affairs, and inter-state commerce. State governments are in law and order, agriculture, health, education, and other matters primarily concerned with the state.
Financial relations: The Constitution mandates revenue sharing between the federal and state governments. The Finance Commission recommends how tax revenues should be divided between the federal government and the states. The federal government also gives grants to states for specific purposes like infrastructure development, health care, and education.
Provisions for taking control of state affairs in times of emergency: The Constitution contains provisions for the central government to take control of state affairs in times of trouble. Article 356 empowers the President to declare the President’s rule in a state, suspending the state government and transferring control to the central government.
Inter-state relations: The Constitution calls for forming an Interstate Council to promote cooperation and coordination between the federal and state governments. The council facilitates the resolution of disputes between states and serves as a forum for discussion of issues of mutual interest.
Financial relations and resource allocation between the central government and state governments are called Centre-State economic relations in India. The Indian Constitution divides financial powers and responsibilities between the Centre and the States.

The following are the critical elements of Centre-State financial relations:

Taxation Powers: The Constitution grants the Centre and the States the authority to levy and collect taxes. The Union government can impose income, customs and excise duties, and service tax, while the states can charge sales tax, value-added tax, and entertainment tax.
Financial Resource Distribution: The Constitution specifies the distribution of financial resources between the Centre and the States. The President of India appoints the Finance Commission, which makes recommendations on allocating financial resources between the Centre and the States. The Finance Commission also determines the Centre’s grants-in-aid to the states.
Revenue Sharing: The Constitution provides revenue sharing between the Centre and the States. Certain taxes, such as corporation tax, income tax, and customs and excise duties, are split between the federal government and the states.
Financial Assistance: The Centre is authorised by the Constitution to provide financial assistance to the states through grants-in-aid. These grants are made available to states for various purposes, including economic development, social welfare, and unique plans.
Borrowing Powers: The Constitution grants the Centre and the States the authority to borrow money. However, if necessary, the Centre can borrow on behalf of the states.
Fiscal Discipline: The Constitution requires the Centre and the States to maintain budgetary discipline and adhere to sound financial management principles.
For many years, financial relations between the central and state governments in India have been a source of contention between the central and state governments.

Here are some of the significant points of contention:

Recommendations of the Finance Commission: The Finance Commission is responsible for making recommendations to the central government on tax revenue sharing with the states. However, there have been concerns that the suggestions are not always followed through on or are ignored, fueling further conflict between the federal and state governments.
Tax Revenue Sharing: One of the most contentious issues is the distribution of tax revenue between the federal government and the states. States frequently believe that they do not receive a fair share of revenue, which limits their ability to fund social and infrastructure programmes. There have been calls for greater fiscal federalism and equitable tax revenue distribution.
Grants-in-aid: The federal government makes grants-in-aid available to states to support various programmes and initiatives. However, states frequently believe that the grants are insufficient and are not distributed fairly. There have been calls for greater autonomy in deciding how to use these grants.
Goods and Services Tax (GST): The introduction of the GST in 2017 was a significant change in India’s taxation system, but it also created conflict between the central and state governments. Some states believe they are not receiving a fair share of the GST revenue and have called for changes to the tax structure.
Dispute resolution mechanisms: Financial disputes between the central government and state governments can be a source of contention. More robust dispute-resolution mechanisms have been advocated to help resolve conflicts and prevent them from escalating.

More excellent dialogue and cooperation between the central and state governments are needed to improve relations, as are increased efforts to address state concerns and ensure that they receive a fair share of revenue.

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