Essay on the Financial Relationship between Centre and State (India)



Financial relations are the most important aspect of Centre-State relations. No system of federation can be successful unless both the Union and the States have at their disposal adequate financial resources to enable them to discharge their respective responsibilities under the Constitution.

To achieve this object, Indian Constitution has made elaborate provisions, relating to the distribution of the taxes as well as non-tax revenues and the power of borrowing, supplemented by provisions for grants-in-aid by the Union to the States. It is to be noted that Indian Constitution makes a distinction between the legislative power to levy a tax and power to appropriate the proceeds of a tax so levied.

The legislative power to make a law for imposing a tax is divided as between the Union and States by means of specific Entries in the Union and State Legislative Lists in Schedule VIII.

Thus, while the State's Legislative has the power to levy an estate duty in respect of agricultural lands, the power to levy an estate duty in respect of non-agricultural land belongs to Parliament.

Similarly, it is the State Legislature which is competent to levy a tax on agricultural income, while Parliament has the power to levy income-tax on all incomes other than agricultural income.

The distribution of the tax-revenue between the Union and the States stands as follows.

(1) Taxes belonging to the Union exclusively:

Customs, Corporation Tax, Taxes on capital value of assets of individuals and companies, Surcharge on Income Tax, Fees in respects of matters in the Union List.

(2) Taxes belonging to the States Exclusively:

Land Revenue, Stamp duty except in documents included in the Union List, Succession duty, Estate duty, and Income tax on agricultural land, taxes on passengers and goods carried on inland waterways taxes on lands and buildings, mineral rights.

Taxes on animals and boats, on road vehicles, on advertisements, on consumption of electricity, on luxuries and amusements, etc. (This is being supplemented by a new system of Value Added Tax i.e. VAT).

(3) Duties Levied by the Union but Collected and Appropriated by the States:

Stamp duties on bills of Exchange, etc., and Excise duties on medical and toilet preparations containing alcohol. (Article 268)

(4) Taxes Levied as Well as Collected by the Union, but Assigned to the States within which they are Levi able:

Duties on succession to property other than agricultural land. Estate duty in respect of property other than agricultural land terminal taxes on goods or passengers carried by railway, air or sea taxes on railway fares and freights and so on.

(5) Taxes Levied and Collected by the Union and Distributed between Union and the States: Certain taxes shall be levied as well as collected by the Union, but their proceeds shall be divided between the Union and the States in a certain proportion, in order to effect on equitable division of the financial resources.

These are:

Taxes on income other than on agricultural income (Art 270)

Duties of excise as are included in the Union List, excepting medicinal and toilet preparations may also be distributed, if Parliament by law so provides (Art 272)

Non-Tax Revenue

Important sources of Non-Tax revenues of the Union are the receipts from Railways, Posts and Telegraphs; Broadcasting; Opium; Currency and Mint; Industrial Commercial Undertakings of the Central Government relating to the subjects over which the union has the jurisdiction.

Similarly for the States are: Forests, Irrigation and Commercial Enterprises and Industrial Undertakings such as soap, sandalwood, iron and steel in Karnataka, Paper in M.P. milk supply in Mumbai, deep sea fishing and silk in West Bengal.


The above mentioned sources are not adequate for the States to carry out the development programmes and the Constitution provides that grants-in-aid shall be made in each year by the Union to such States as Parliament may determine to be in need of assistance; particularly for the promotion of welfare of tribal areas, including special grants to Assam (Art 275).

Articles 270, 273, 275 and 280 provide for the constitution of a Finance Commission to recommend to the President certain measures relating to the distribution of financial resources between the Union and the States, - for instance, the percentage of the net proceeds of income-tax which should be assigned by the Union to the States and the manner in which the share to be assigned shall be distributed among the States (Art 280).

By the way of safeguarding the interests of the States in the Union, taxes which are divisible according to the foregoing provisions, it is provided by the Constitution (Art. 274) that no bill or amendment which varies the rate of any tax or duty in which the States are interested or affects the principles on which moneys are distributable according to the foregoing provision of the Constitution or imposes any surcharge on any such tax or duty for the purposes of the Union shall be introduced or moved in Parliament except on the recommendations of the President.

As in the case of legislative and administrative spheres, so in financial matters, the normal relation between the Union and the States (under Arts. 268-279) is liable to be modified in different kinds of emergencies.

(1) While a Proclamation of Emergency (Art. 352(1)) is in operation, the President may by order direct that, for a period not extending beyond the expiration of the financial year in which the Proclamation ceases to operate, all or any of the provisions relating to the divisions of the taxes between the Union and the States and grants-in-aid shall be suspended (Art 354).

In the result, if the President makes any such order, the States will be left to their narrow resources from the revenues under the State List, without any augmentation by contributions from the Union.

(2) In case of Financial Emergency (Art. 360(1)) is made by the President, it shall be competent for the Union to give directions to the States

(a) To observe such cannons of financial propriety and other safeguards as may be specified in the directions;

(b) To reduce the salaries and allowances of all persons serving in connections with the affairs of the States, including High Court Judges;

(c) To reserve for the consideration of the President alt money and financial bills, after they are passed by the Legislature of the State (Art 360)

A major problem, faced in a system with multiple fiscal authorities, is integration of financial policies, which is an objective in a planned economy. Another problem arises due to the imbalance of financial resources between the Centre and the States.

The difference in levels of economic development leads to imbalance between different States in terms of income and wealth disparities. This inter-State imbalance also creates perennial source of tension with the Centre.

The most important problem for all the state governments is the shortage of financial sources within the present structure of Centre-State relations. On the one hand, the financial requirements of the states are vastly increasing, and on the other hand, the Centre has been gradually encroaching on financial powers and cornering for itself a major share of the total national resources.

Another tendency noticed has been the increasing indebtedness of the States to the Centre for various developmental purposes. The states are finding themselves unable to repay the installments or interests on the debts without further central assistance.

The Seventh Schedule of the Constitution vests the taxing powers both in the Union List and the State List but there is a contradiction between the elastic sources of revenue earmarked for the Centre' and the expansive developmental expenditure of the States.

Provision of grants-in-aid have been made in the Constitution whereby the Union as a guardian may extend financial help to various units in times of need and for their all round development.

The scheme of financial relations between the Union and the States is flexible and adaptable to varying needs according to different situations. Resources and needs are reviewed periodically by a Finance Commission, which recommends the requisite changes, derived on the basis of experience and resources, to be made in the distribution of finances between the Union and the States.

This is a unique feature of the Indian Constitution. In fact, by providing for the establishment of the Finance Commission for the purpose of allocating and re-adjusting the receipts from certain sources, the Constitution has made an original contribution in this extremely complicated aspect of federal relationship.

The Union and States 'are mutually dependent' and this coordinate nature has given stability to the working of the Indian federation.

Our Constitution had adopted the desirability of the Finance Commission which by all accounts can provide the most logical and fair institution method as successive Finance Commissions have made valuable contributions to our federal system. Every State wants more resources, and a larger share of the divisible pool.

The Finance Commission is to do justice between the Centre and the States, and between a State and a State. Its purpose is to assure the States that they will have a fair deal. After the constitution of the Planning Commission, the Finance Commission's role in allocation of resources to States has been devalued to a great extent.

So far, the total dispensation of fiscal transfers through the Finance Commission and plan allocations through the Planning Commission have increased rather than narrowed down regional imbalances, and if this trend is to be arrested, radical change in the pattern of financial assistance to States is called for.

The State governments generally prefer allocation of fiscal resources through the Finance Commission, as it is a constitutionally mandated body, whereas the Planning Commission is a creation of the Union government through an ordinary executive order.