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Financial Relations Between Centre And State

Federalism in India

The government of India is formed on the concept of federalism, which means that the centre of the government as well as its various constituent units shall enjoy the same power. India is a federation of 29 States and 8 Union Territories, and while 6 Union Territories are governed by the central government directly, the Union Territories of Delhi and Puducherry, and the 29 States form their own governments, which are subject to the Centre.

Federalism finds its place in Part XI of the Indian Constitution, which lays down the distribution of legislative, administrative, and executive powers between the Centre and the States. Federalism propagates that there shall be two or more levels, or tiers, of government, and each level shall have jurisdiction while dealing with matters specific to it. This jurisdiction exists with respect to all matters, and whenever there is a disagreement between the Centre and one or more State, the independence of our judiciary comes into play and the dispute is settles by the Supreme Court of India.

However, powers as distributed between the Centre and the States cannot be equal because of practical reasons. Matters of national security may be better handled by the Centre alone, whereas construction of roads or highways in an area may be looked into by the State. Consequently, India follows a quasi-federal structure of government, whereby the Centre enjoys more powers altogether as well as on certain issues, than the States.

The Three Lists

For a cleaner division of power between the Centre and the States, the Constitution consists of three lists, namely, the Union List, the State List, and the Concurrent List, which are mentioned under Article 246 of the Constitution.

The Union List contains 100 items, on which the Union Parliament alone can legislate, the State List of 61 items on which the State Legislative Assemblies alone can legislate, and the Concurrent List, on which both, the Parliament and the Legislative Assemblies can legislate. Often times, both the levels of government have clashed when it comes to matters pertaining to the Concurrent List, and the dispute has been referred to the Supreme Court. But even then, the Union has been given more power in the sense that in case both the levels of the government legislate on any item in the Concurrent List, the law of the Centre shall prevail over that of the State. Even for certain items in the State List, the Centre has power to legislate under specific situations.

As for subject not covered under any of the three lists, or residuary subjects, the Parliament as well as the State Legislative Assemblies both, have the power to legislate, but this is according to the provisions of the Constitution. Excluding those, the power to legislate on residuary subjects rests with the Parliament, as per Article 248.

Division of Financial Powers in India

Taxes are levied by the Centre and the States, but the type of taxation that is levied is different.

The Union government can levy taxes such as tax on income, other than agricultural income, Customs and Export Duties, Excise Duties on certain goods, Corporation Tax, Tax on capital value of assets, excluding agricultural land, Terminal taxes, Taxes other than stamp duties etc.

The State government can levy taxes on agricultural income, lands and buildings, mineral rights, electricity, vehicles, tolls, professions, capitation, as well as collect land revenue, and impose excise duties on certain items.

The Concurrent List does not have any major taxation in order to avoid clashes between the levels of the government as well as economic exploitation of the citizens of the country, in case the same tax was to be levied by the same authority. Articles 268 to 281 of the Constitution of India comprehensively sets out the levying and collecting of taxes.

Constitutional Provisions on Financial Relations Between Centre And State

Article 268 mentions taxes that are levied by the Centre but kept by the States, such as stamp duties.

Article 269 mentions taxes levied and collected by the Centre but assigned for the States. It includes taxes on the sale and purchase of goods as well as taxes on consignment of goods. Taxes include central sales tax, estate duty tax etc.

Article 270 mentions taxes levied and distributed between the Centre and the States. It includes the major tax on income, and also basic customs duty, excise duty on non-GST items. Article 270 also lays down the procedure for appropriation of certain taxes, and any surcharge on taxes or duties levied as per Article 271, or any specific cess.

Articles 273, 275 and 282 mention grants-in-aid by the Centre to the States. Article 273 was relevant only up till a period of 10 years from the commencement of the Constitution, while 275 talks about statutory grants and 282 discretionary grants.

Article 276 levies tax on professions, employments, trades and callings, but the total amount is not to exceed 2500 rupees per year. As per Article 277, any taxes or cesses levied before the commencement of the Constitution by the government of any state or municipality in a lawful manner, they would continue to be levied as long as the Parliament does not come out with any law against the same.

Finance Commission

The Finance Commission mentioned under Article 280 gives recommendations with regard to the distribution of taxes between the Centre and the State. The composition, powers and functions of the Council are mentioned thereby.

As per the Article, the President shall create a Finance Commission every five years, and it is the duty of the Commission to assist the President on matters of distribution of net proceeds between the Centre and the States. The purpose of setting up of a Finance Commission is to make sure that the distribution of the net proceeds of taxes between the Centre and the States is fair and does not impair the autonomy of any authority.

The Finance Commission constitutes of five persons, out of which the Chairman is to be appointed by the President. The qualifications for the rest of the members include:

  • Being a judge of a High Court, or a person qualified enough to be a member of the Commission,
  • Having deep knowledge of financial matters and accounts of the Government
  • Having relevant experience in the field of finance and administration
  • Having an understanding of economics

The Finance Commission not only aids the President in matters of net proceeds, it also lays down guidelines regarding grants-in-aid out of the Consolidated Fund of India, suggests effective usage of the Consolidated Fund of the States to help the Panchayats and Municipalities of the State, as well as delivers its suggestions on other financial matters. If any dispute arises in any of the matters dealing with the Finance Commission, it can function in the capacity of a civil court and exercise the powers of the same. Over the years, the Commission has played a very important role in strengthening the financial structure of the country. Its sound recommendations and suggestions, as well as its work has redefined the economic scenario and has helped the government devise efficient fiscal laws and policies.

GST Regime

A major change penetrated the economic structure of India with the introduction of the Goods and Services Tax. The government came out with the Goods and Services Bill in 2017 and soon, it was implemented as a tax. To put it simply, the GST (Goods and Services Tax) is a Value-Added Tax imposed on a number of goods and services that are sold for domestic consumption. GST is paid by the consumers at the point of sale and is collected by the government through the seller. The main aim of introducing GST was to have a single and unified system of taxation; it merges the taxes levied by the Centre with those levied by the States. The system before the implementation of GST meant that tax would be paid at every stage of the manufacturing process, while GST ensures that tax is collected only at a single stage, and it would help in reducing inflation in the upcoming years.

Implementing GST led to the overlapping of taxes, which led to amendments in the Constitution accordingly. The tax is levied as a dual system of Central GST (CGST) and State GST (SGST), but concurrently. Whereas, the Parliament holds exclusive power to levy GST on inter-state trade and commerce (IGST) on both, goods and services, as well as to levy excise duty along with GST on tobacco and tobacco products.

Article 246A states that with regard to GST, both, the Centre as well as the States will have the power to make laws on inter-state trade. Read with Article 270(1A), taxes so collected will also be distributed between the Centre and States. As per Article 270(1B), the central portion of the IGST is also liable to be distributed between the Centre and the States.

A GST Council was set up in order to implement the GST and take decisions related to it in the future, which comprises of the Finance Minister of the Centre, the Minister of State for Revenue, and the Finance Ministers of the States.

Overview of Financial Relations Between Centre And State

The Constitution also contains provision for the Union as well as the States to borrow from each other, conferred upon by Articles 292 and 298. However, the disparity between the powers is enormous, and the powers are enjoyed mostly by the Centre, because the powers awarded to the States carry with them limitations. States are not allowed to raise loans outside the Union Government, and the process of acquiring loans is a very stretched out one. Moreover, in situations of deficit, the Centre is allowed to fill up by borrowing from the Reserve Bank of India, whereas States have to have adherence to the overdraft limit prescribed by the RBI itself. In cases of national emergency, the grants-in-aid remain suspended for a particular period of time, but under financial emergency, the situation changes dramatically. The Centre acquires extensive power and can mandate the States to act as per certain norms and safeguards, such as reduction in salaries of government employees, including judges of the High Courts, altering the distribution of taxes between the Centre and States in order to observe financial propriety, and reserving the direction of the President on matters related to finance even after getting passed by the State Legislature.

Considering all the facets of the financial relations between centre and state, it can be concluded that no one State can exist independently, without financial assistance from the Union. In India, as opposed to other countries, the dependence of States on the Union is far greater. This financial constraint is what needs to be checked, because otherwise the States cannot perform well in terms of development. Financial resources are the backbone for any form of progress, and a greater degree of cooperation between the Centre and the States is what is required for the country to reach its maximum potential.

FAQs on financial relations between centre and state

In what ways a federal structure of government defines the financial relationship between the centre and its constituent units?

Federalism means that there will be two or more levels, or tiers, of government, in a country, and each level shall have jurisdiction while dealing with matters specific to it. It also follows for financial matters: the centre shall manage its own financial resources and the constituent units their own. But that does not imply extreme separation of matters, rather it means co-dependence.

List the major constitutional provisions that define the financial relations between the Union and the States in India.

The following constitutional provisions lay down the distribution of financial resources between the governments of both the levels:
1) Article 268 mentions taxes that are levied by the Centre but kept by the States, such as stamp duties.
2)  Article 269 mentions taxes levied and collected by the Centre but assigned for the States. It includes taxes on the sale and purchase of goods as well as taxes on consignment of goods. Taxes include central sales tax, estate duty tax etc.
3) Article 270 mentions taxes levied and distributed between the Centre and the States. It includes the major tax on income, and also basic customs duty, excise duty on non-GST items. Article 270 also lays down the procedure for appropriation of certain taxes, and any surcharge on taxes or duties levied as per Article 271, or any specific cess.
4)  Articles 273, 275 and 282 mention grants-in-aid by the Centre to the States. Article 273 was relevant only up till a period of 10 years from the commencement of the Constitution, while 275 talks about statutory grants and 282 discretionary grants.
5)  Article 276 levies tax on professions, employments, trades and callings, but the total amount is not to exceed 2500 rupees per year. As per Article 277, any taxes or cesses levied before the commencement of the Constitution by the government of any state or municipality in a lawful manner, they would continue to be levied as long as the Parliament does not come out with any law against the same.

How did the introduction of GST impact the financial relations between the Centre and the States?

Introducing GST in the Indian economy brought a change in the financial relationship between the Union and the States. It led to the overlapping of taxes, due to which relevant amendments had to be made in the Constitution. Presently, the tax is levied as a dual system of Central GST (CGST) and State GST (SGST), but concurrently. Whereas, the Parliament holds exclusive power to levy GST on inter-state trade and commerce (IGST) on both, goods and services, as well as to levy excise duty along with GST on tobacco and tobacco products. Article 246A of the Constitution states that with regard to GST, both, the Centre as well as the States will have the power to make laws on inter-state trade. Read with Article 270(1A), taxes so collected will also be distributed between the Centre and States. As per Article 270(1B), the central portion of the IGST is also liable to be distributed between the Centre and the States.

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