Fiscal aspects of Federalism: Critiqal Appraisal of Relationship between Centre and States


Muhammad Riyazul Ameen Memon


Final Year Student, Hidayatullah National Law University, Raipur


The term federal has been derived from the Latin term ‘foedus’ which means treaty or agreement. Such treaty or agreement follows the merger of a number of separate states into a single sovereign State. The objective of agreement is to arrive at a compromise, among the interests of the central authority which comes into being as a result of merger of the states on the one hand and the various states which are transformed into constituent units of that political structure on the other hand.


In India before Independence, the remarkable feature of financial relations was that except for a brief period in the early twenties when the Provinces were required to make contributions to cover the Central budgetary deficits or shortage, it was mainly the Union Government which transferred resources to the Provinces to meet their expanding necessities. It had a unitary system of government and till the end of 19th Century the Provinces depended entirely on the Central Government for all their necessities. The provinces had neither the right to impose tax and raise resources nor to undertake expenditure on themselves. They were paid fixed cash grants called cash assignments for meeting their expenses which were reviewed from periodically. This arrangement was found to be unsatisfactory. Thereafter Provinces were given the right to collect revenues from law, forests and justice, public works, education, etc. which were of local origin. They were also given a share of certain Central taxes like excise duties, and income tax, stamps etc. This allocation came to be known as 'divided heads of revenue’. The method of paying cash assignments also continued. In the starting such ‘settlements’ were subjected to review every five years. The settlements with the provinces were made quasi-permanent in 1904, and permanent in 1912. This made the Provinces less dependent on the fluctuating grants from the Union.


Like in other countries, the financial or fiscal dimensions of federalism are a reflection of the political federal structure in India. The traditional subjects of concern of fiscal federalism such as the assignment of taxes and responsibilities as well as the correction of vertical and horizontal differences continue to remain significant in India. Devolution of duties and taxes still comprises the most significant dimension of fiscal federalism in India. As a paramount objective fiscal federalism is expected to enable the national and sub-national governments to operate in such a way that leads to efficiency in the use of resources not only in terms of the quality of services provided by the various levels of government but also in terms of creating the environment in which all economic agents use resources capably.



Union-State relations with regard to fiscal field are complex and have come under severe strain in every federal system of the world. India is no exception. The core of the clash is resources and their allocation. It is supposed that to ensure financial autonomy of the States  they should have sufficient resources to discharge their functions and duties as welfare states. But in no federation of world it has been feasible to provide for fiscal distribution of resources to correspond to the needs. The States have to depend for the financial assistance from the federal government. Such dependence not only affects autonomy of the States but also becomes a source of constant friction between the federal the States and government.


In India, the problem is more sensitive. A country which is so vast and with so much socio-economic differences, it is very important to vest the Centre with authority to exercise reasonable financial control over the States and to make it strong to keep the country united. At the same time allocation of independent resources to the States is also necessary. What grade of financial independence is appropriate for the purpose is as much a matter of debate and consideration today as it was when the Constitution was drafted. In order to overcome the difficulties experienced in other federations, India has made a bold effort to deal with the complex issues involved in the allocation of resources. Indian Constitution has made such elaborate provisions with respect to financial relations.


In our Constitution a distinction has been made between general subjects of legislation and legislative process concerning to taxation. The subjects relating to taxation are dealt with in a one group of Entries while the general subjects of legislation are dealt with in separate group of Entries. For instance, in List I, Entries 1 to 81 deals with general matters of legislation while Entries 82 to 92A deal with taxes. Likewise in List II, Entries 1 to 44 deals with general matters of legislation and Entries 45 to 63 deal with taxes. The residuary powers of legislative taxation have been vested in the Union under Article 248 of the Constitution read with Entry 97 of the centre or Union List.


Further under the Constitution the main subject of legislation is dealt with separately from tax power which may be levied in relation to that subject. For example Entry 22, List I (Railways) with Entry 89 (Terminal taxes on goods or passengers Carried by rail, sea or air, taxes on railway fares and freight). In list II, Entry 18 states with land and transfer and alienation of agricultural land; Entries 45 to 49 provide respectively for land returns, for duties in respect of succession to agricultural land, for estate duty in respect of agricultural land, for taxes on agricultural income, and taxes on lands.

Other fundamental principle underlying our scheme of allocation of resources is that the taxing power of the Union and of the States are mutually exclusive. For example, by the comparison of the Entries 82, 87 and 88 of List I with Entries 46,47 and 48 of List II. While the Union can levy tax on income other than estate duty in respect of property other than agricultural land and duties in respect of succession to property other than agricultural land agricultural income, the States can levy tax on agricultural income, taxes in respect of succession to agricultural land and estate duty in respect of agricultural land. Such mutual exclusiveness is further emphasize by the fact that the Concurrent list contains no Entry relating to tax but only contains an Entry for fees.


A cursory glance at the scheme of distribution of taxes would indicate that while as many as 19 taxable items are allotted to the States only 13 areas fall under Union jurisdiction. However, A closer look reveals that the Centre has been given the resilient and expanding sources of revenue and on the other hand the States have been given inelastic and even eroding sources of revenue or revenue. Although the State legislature has power to levy any of the taxes enumerated in the State List but in certain cases such power is subject to certain limitations imposed by Articles 285, 286, 287 and other provisions of the our Constitution. The sales tax, is the most elastic source of revenue of a State, has been subjected to certain limitations. State has power to impose taxes on “the sale or purchase of goods other than newspapers”. However taxes on the sale or purchase of goods in the course of inter-state trade or commerce as also taxes on imports and exports  are exclusive Union matters.


Right from the beginning, it was recognized that the revenue from the taxes assigned to the States would be inadequate to enable them to discharge their liabilities and devolution of resources from the Union to the States is obvious. Under Indian Constitutional scheme resources given to the Union are not meant solely for Union purposes and the resources have not been distributed between the two units of the Federation in watertight compartments as is usual under a Federal structure. This principle has also been adopted by the Supreme Court in the matter of In re; The Sea Customs act.


There is a growing demand among the States for more fiscal autonomy to make their autonomy a reality. In the present political situation, the problem deserves serious consideration. It is to be considered that whether some of the sources of revenue at present allotted to the Centre could be shifted to the State. But the country being a single economic entity and after taking into account the principles of efficiency and administrative convenience, there can be no clear-cut division of tax resources between the Union and the States. It is submitted that the present division of tax resources is well conceived. There is no possibility for transferring more tax resource from the Centre to the States. The States cannot be expected to be financially independent of the Centre. However, it is necessary to take suitable steps to reduce their financial dependence in an objective manner.


A enduring solution to the problem of the fiscal autonomy of the States is that the States must strive to exploit their tax potential to the desired extent and there should be a vigorous and concerned drive against loan recovery avoidance, eradication of wastes, extravagance in public expenditure and tax evasion. There is also a controversy between Centre and States over the basis of distribution of the divisible pool of the shared taxes amongst different States. It is suggested that population and relative per capita income may be regarded as the basis of distribution as already exists.


Also the States instead of bringing intense pressure on Centre for transfer of ever increasing amount or resources from die divisible pool or otherwise should undertake to improve their own resources by better management of public undertakings, cutting down all non-essential expenditure and refraining from populist measures plugging the loopholes in the collection of revenue, and having recourse to tough measures for mobilization of additional resources. Similarly, the Union Government should monitor strict fiscal discipline and not resort to deficit financing. It should truly try to understand the problems and difficulties of the States in their right perception without any bias. Also the Centre should not allow the opposition ruled States to entertain even the remotest feeling that these are being discriminated on the basis of political difference of approach.



1.       Anderson, William, Inter-governmental fiscal Relations, 2(1956).

2.       Ibid.

3.       Entry 35 of the Concurrent List is not an exception because it refers to the principles on which taxes on   mechanically propelled vehicles are to be levied. The subject matter of tax is under Entry 57 of the State List.

4.       Entry 54 of List II.

5.       Entry 92 A of List I.

6.       Entry 83A of List I.

7.       A.I.R. 1963 SC 1760 at 1771,

8.       Federalism Autonomy And Centre-State Relations by Chaubey,               R.K. Satyam Books Publishers, 2007


Received on 15.02.2014

Modified on 28.02.2014

Accepted on 15.03.2014

© A&V Publication all right reserved

Research J. Humanities and Social Sciences. 5(1): January-March, 2014, 26-28