Center-State Finance Relations

Unlike US model based on dual federalism, which ensures financial autonomy of the states, India has adopted cooperative federalism where the two levels of government  are interlocked. In Indian scheme, center acts as a ‘big brother’. Thus even in financial matters  constitution ensures  dominance of the center.

Why center has been given dominant role?

1) Regional imbalance because of colonial policies. Hence all resources generated in a state, cannot be kept entirely under the state. It will create more imbalance, which is not good for the stability. 
2) Centralized planning to achieve faster economic growth, hence it was natural that center controls more amount of resources.

Analysis of the distribution of taxes

1| High yielding and more elastic taxes have been kept under Union. However Union’s revenues are not just for the use of Union. It is to be distributed among states as per prescribed formula. This will address 1) Vertical imbalance  2) Horizontal imbalance.  [ Imbalance means difference between expenditure and revenue. ]
2| States also have power to impose taxes, however taxes kept under the state are not high yielding, rigid and thus not sufficient. Hence states are made dependent on center.

Ways in which states get resources.

1] Borrowings.

Concerns of state government.
State governments power of borrowing is limited. 
1) They cannot borrow from outside the country. 
2) In the domestic market also, there are limitations –
a) In case they have borrowed from Union government, and the loan remains outstanding, they cannot borrow from the market without the permission of the Union government. 
b) In case they have borrowed from the market. And in such case the counter-guarantee is given by Union, they cannot get fresh loans without the approval of the union.
 

2] Grants in aids

There is a provision for Grants in aid of revenue. There are two types of grants.
1) Statutory Grants
Grants under Art 275, provided to needy states.
2) Discretionary Grants.
These are called discretionary because both Union and state governments can give these grants for any public purpose even when it does not come within their legislative competence. It comes under Art 282.
There is also a dispute with respect to discretionary grants between union and states. It also created conflict between finance commission and planning commission.

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3] Distribution of taxes

The constitutional scheme of the distribution of taxes is continuously evolving. The recent amendment is 101 Amendment Act.

Distribution of Taxes before 101 Amendment Act (GST)

Changes introduced by 101st Amendment Act (GST)

Other changes introduced by 101 Amendment Act

1] Introduction of Art 246A.
Concurrent powers of Union and state to levy GST. Power of Union to levy GST in case of inter-state trade and commerce.

2] Introduced Art 279A.
It introduces a new body, GST Council.

GST Council
Voting pattern – weighted voting. 1/3rd weightage to the weight of union, 2/3rd weightage to the vote of states.
To pass any decision, 3/4th of the votes are required.
It makes GST 3 legged race. States have to cooperate with states, Union and states have to cooperate with each other. India has introduced dual GST. Both Union and State will have power. It is not one country, one tax rather, harmonization of taxes. The council will decide bandwidth. (Floor rate and ceiling rate.)

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Various Issues.

1] Implication of GST on federalism.

Whether GST strengthens federalism or weakens federalism will depend on our perception of federalism. If we define federalism in terms of strengthening of states, GST weakens the states. If we define federalism in terms of cooperative federalism, GST forces the units of federalism to cooperate.

Those who consider GST as anti-federal give following arguments.

1| Federalism is a political contrivance where units desire unity without uniformity. Hence introduction of one tax goes against the spirit of federalism. We can take the example of USA, despite being the most advanced market economy, USA has not gone for introduction of GST.

2| Sales tax has been the most important source of revenue for the state governments. Now they do not have complete freedom to determine the rate of the tax.
Sales tax had been one of the most contested issue in the constituent assembly. Ambedkar, who always favored strong center, had the view that state governments should be given complete autonomy in determining the rate of sales tax. Constitution should not prescribe any limit.

3| Sales tax has been a major method for the states to pursue the public policy of their choice. If we go by principle of federalism, it should be the choice of the state to decide. e.g. If govt. of Bihar believes in banning of liquor, even when it amounts to the loss of revenue, it is their choice. Similarly, if state of Gujarat wants to promote manufacturing, state of Tamil Nadu aims to invest in health and education, it should be their choice.

4| There are concerns of manufacturing states because GST is a destination based tax.

On the other hand, those who believe in the spirit of cooperative federalism, they believe that
1| GST compels all the units to cooperate. They believe that GST will convert tangles of the relations to tango.
2| If states have monopoly over determining rates of sales tax, they also get power to levy service tax.
3| It is believed that in the long term, the revenues of the states will increase, will give them more resources.

2] Concerns with Planning Commission

1) Planning commission was extra-constitutional, non-statutory body. 
2) Planning commission impacted the cabinet system
It became super cabinet. Planning commission not only made policies but also had powers to determine the outlays. Thus it reduced ministries to the level of implementing agencies. The members of planning commission were hand-picked by the prime minister, they were not elected by the people yet became the major power in the system.
3) Planning commission reduced the scope of finance commission. There was no constitutional limitation on finance commission in determining grants. Finance commission could have determined the criteria for both type of grants. However, because of Planning Commission, the system developed were finance commission used to decide the revenue grants and Planning Commission to decide the grants for development. Hence Planning Commission had to decide over huge outlays in comparison to finance commission. Hence Planning Commission became more powerful.

Comparison between Planning Commission and NITI Aayog

Planning commission had become anachronistic. Planning is a feature of socialist economy rather than market economy. Market economy is based on demand and supply. Socialist economy is supply driven. Socialist economy is directed by the state.
In 1990s India shifted from state-directed towards market-driven economy. Hence the nature of planning also changed from centralized to indicative. Unlike centralized planning, where govt. will not only determine the priorities but also the allocation of resources, indicative planning means govt. will only give indications to the market or private player about government’s priorities e.g. If the priority of government is promotion of cement industry, it will make such policies, incentives which will attract private players to invest in that industry. Present government has ended even indicative planning.
Present government has abolished Planning Commission and introduced NITI Aayog on 1st Jan 2015. NITI Aayog is a policy making institution rather than planning institution.

3] Approach of NITI Aayog.

According to Prime Minister, NITI Aayog is based on cooperative federalism. Cooperative federalism in true sense. States will be involved in the formulation of policies since inception. State will determine their priorities. The modality in the NITI Aayog is working groups of the interested states.
NITI Aayog is also based on the vision of ‘team India’. It means it also includes private sector in the formulation of policies. According to the Prime Minister, it is a ‘bottom up’ approach. NITI Aayog has transferred the power to make allocations to finance ministry. Instead of planned document, it has produced 3 years agenda for reforms. According to Balveer Arora, NITI Aayog is the imperfect clone of the institution which it aimed to abolish.

4] Finance Commission.

It is entirely a Union body. Neither in the selection of the members nor in deciding terms of reference, state governments have any say.
Paradoxically, Planning Commission did include state governments at different stages of planning through the platform of NDC (National Development Council).
Another paradox is that NDC itself was entirely a political platform. Decisions have been based on party politics.

Fifteenth Finance Commission.

Recently there has been grievance of state governments towards the terms of reference of 15th Finance Commission. Union has asked to consider 2011 census data in place of 1971 population data.
Union govt. has asked suggestion with respect to
1| The discontinuation of revenue deficit grants.
2| Suggests additional conditionalities on borrowing powers.
3| Grants linked to performance – the question is whether finance commission is a the right institution to access the performance.
4| Conditionalities to maintain fiscal discipline.

5] Fiscal Discipline

Union government has asked finance commission to suggest additional conditionalities on the powers of state governments. Concerns of the state government is that Union imposes fiscal discipline on state governments, but is not concerned about the fiscal discipline at the Union level.
There is a conflict with respect to fiscal responsibility budgetary management act. (FRBM Act). Which expects state to keep their fiscal deficits minimal. (Not more than 3% of GDP). It is to be noted that under the constitution the main responsibility for the development is on state governments. However they do not have sufficient resources. The policies aiming at reducing the fiscal deficit is based on ‘neo-liberal’ ideology imposed by IMF. Such policies are not appropriate for developing countries like India where government needs to invest heavily in development.

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