Fiscal federalism governs the assignment of taxation powers, revenue-sharing, and expenditure responsibilities across federal tiers. In India, Centre-State financial relations have evolved from discretionary planning transfers toward rule-based statutory devolution, though structural asymmetries continue to influence state autonomy.

Evolving Pattern of Centre-State Financial Relations

• The Planned Development Era: For decades, the Planning Commission directed resource transfers via discretionary Plan Grants under Article 282, often overshadowing statutory Finance Commission devolutions under Article 275 and creating centralized spending priorities.
• Shift to Finance Commission Primacy: The abolition of the Planning Commission in 2014 and the creation of NITI Aayog restored the Finance Commission as the primary institution for resource sharing.
• Enhanced Tax Devolution: The 14th Finance Commission increased the states’ share in the net divisible pool of central taxes from 32% to 42% (adjusted to 41% by the 15th FC following J&K’s reorganization), expanding untied fiscal space for state governments.
• Expansion of Centrally Sponsored Schemes (CSS): Conditional grants under tied schemes continue to influence state budget allocations, requiring matching state contributions.

Challenges in Contemporary Fiscal Relations

• Persistent Vertical Fiscal Imbalance: The Union collects the majority of broad-based revenues, while states handle substantial socio-economic delivery responsibilities. States’ own tax revenues generally account for less than half of their total expenditures.
• Horizontal Disparities: Income-distance criteria used in devolution formulas sometimes generate debates between higher-contributing industrialized states and resource-constrained states with larger populations.
• Proliferation of Cesses and Surcharges: Cesses and surcharges collected by the Union under Articles 270 and 271 bypass the divisible pool, reducing the effective share of total central revenue devolved to states.
• Conditionality on Borrowing: State borrowing limits under the Fiscal Responsibility and Budget Management (FRBM) frameworks are often linked to central conditions (such as power-sector reforms).

Impact of Recent Reforms on Fiscal Federalism

1. Positive Impacts

• Institutionalized Cooperative Federalism via GST: The Goods and Services Tax (GST) Council created a joint constitutional decision-making body (Article 279A) where Union and States collectively determine indirect tax rates.
• Predictable Tax Allocations: Multi-year Finance Commission formulas provide predictable transfers, enabling states to plan long-term development outlays.
• Incentivizing Structural Reforms: Special assistance packages offer long-term, interest-free capital loans to states that meet specified capital expenditure and reform milestones.

2. Concerns and Challenges

• Erosion of State Tax Autonomy: Subsuming state levies (VAT, entry tax, luxury tax) into GST limits states’ independent ability to alter tax rates in response to regional emergencies.
• Compensation Expirations: The end of the guaranteed five-year GST compensation transition in 2022 created fiscal adjustments for states with narrower revenue bases.

India’s fiscal federalism has moved toward formula-based devolution and cooperative tax governance. Strengthening trust will require containing non-divisible surcharges, rationalizing centrally sponsored schemes, and supporting state fiscal flexibility.