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Rethink the dynamics of India’s fiscal federalism

GS Paper 3

 Syllabus: Government Budgeting


Source: TH

 Context: The evolving dynamics of India’s fiscal federalism require reconsideration due to various factors, such as the shift to a market-based economy, changes in the fiscal landscape, and amendments to the Constitution.


What is the meaning of India’s fiscal federalism?

India’s fiscal federalism refers to the division of financial powers and responsibilities between the central government and state governments within the framework of a federal system. It involves how revenue is generated, shared, and utilized to fund public services and governance across different levels of government in the country.


Issues with the India’s fiscal federalism:

  • Replacement of Planning Commission with NITI Aayog.
  • Authority of GST Council under Goods and Services Act.
  • Impact of widespread cess and surcharges on divisible pool size.
  • Neglect of integrating the third tier of governance.
  • Lack of consistent financial reporting across all government tiers.
  • No comprehensive review of off-budget borrowing practices.
  • States are subject to restraint through Article 293(3)under the oversight of the Union and the FRBM Act, but the Union frequently evades such checks.
  • The substantial use of the National Small Saving Fund (NSSF)for financing central PSUs through loans is not included in the Union’s fiscal deficits.


Issues of Fiscal Federalism w.r.t GST:

1. Financial Autonomy of StatesGST has made the country’s indirect tax regime more unitary, reducing states’ financial autonomy.
2. GST CompensationStates were promised compensation if revenue growth fell below 14%, but the Centre missed payments, causing friction.
3. GST CouncilThe central government’s vote counts for one-third, giving it considerable influence; A Recent Supreme Court ruling grants states flexibility in decision-making.
4. Revenue ShortfallStates face a significant GST revenue gap, causing financial challenges and impacting fiscal federalism.


Why is there a need for re-evaluating Article 246 and the Seventh Schedule?

  • Changing Political Landscape: India’s shift from a single-party to a multi-party system has led to new dynamics in governance.
  • Altered Dynamics: Changes in politics, society, technology, demographics, and development approaches have significantly transformed the landscape.
  • Additional Burden: Central legislations like MGNREGA, RTE Act, and NFS Act have placed extra responsibilities on states.
  • Constitution-Making Gap: The original constitution-making process didn’t adequately address the division of responsibilities and taxation authority.
  • Borrowed Framework: The constitution borrowed heavily from the Government of India Act 1935, lacking the subsidiarity principle.
  • Missed Opportunity: The 73rd and 74th Constitutional Amendments provided a chance for reconsideration, but no substantial steps were taken.
  • Complexity Introduced: Introduction of Schedule XI and Schedule XII complicated matters without clear operational significance.
  • Need for Specificity: These schedules need to be broken down into specific activities and sub-activities, similar to Kerala’s approach, for practical relevance.


What should be done:

  • Equity in Intergovernmental Transfers: India’s transfer system should prioritize equity. The 16th Finance Commission should focus on equity in tax devolution.
  • Revisiting Article 246 and Seventh Schedule
  • Subsidiarity Principle for Division of Functions: The introduction of a new local list detailing the responsibilities of local governments is necessary.
  • Empowering the Third Tier: Recognizing local governments’ role, the upcoming Union Finance Commission should address this.
  • Reviewing Off-Budget Borrowing: Off-budget borrowing practices by both the Union and States need review. Transparency is crucial, and all income and expenditure transactions should be accounted for within the budget.


Insta Links:

 The poor state of India’s fiscal federalism


Prelims Links:

Which one of the following is not a feature of Indian federalism? (2017)

(a) There is an independent judiciary in India.

(b) Powers have been clearly divided between the Centre and the States.

(c) The federating units have been given unequal representation in the Rajya Sabha.

(d) It is the result of an agreement among the federating units.


Ans: (d)