Centre-State Financial Relations, Economy Traditional UPSC Notes | EduRev

Economy Traditional for UPSC (Civil Services) Prelims

UPSC : Centre-State Financial Relations, Economy Traditional UPSC Notes | EduRev

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Centre-State Financial Relations

  • As India has a federal system of government, the Constitution seeks to make a clear division of financial resources between the Centre and the States. 
  • At the same time, the framers of the Constitution were aware that the allocation of financial resources did not correspond with the assigned functions and that the resource gap in the States might widen over the years. 
  • They provided for the distribution or devolution of resources from the Centre to the States. It was specifically for this purpose that Article 280 provides for the setting up of a Finance Commission by the President every five years or earlier.


Distribution of Resources

The transfer of resources from the Centre to the States are of three types–

  1. Share in Taxes and duties;
  2. Grants;
  3. Loans.

Grant-in-Aid – There is a provision for grants-in-aid by the Centre to the States for specific purposes (under Article 275 and quantum is decided by Finance commission) or any public purpose (under article 282 and quantum is decided by the Centre on its own discretion). 
The grants also serve the purpose of correcting inter-State disparities in resources. They also help in the exercise of a certain measure of Centre control and co-ordination over essential welfare services and development programmes in different States.

Loans – The State are authorised to raise loans in the market but they also borrow from the union government which gives the latter considerable control over State borrowing and expenditure. 
The rate of annual borrowing by the States from the Union has considerably increased during recent years.


Transfer of Resources

  • Financial resources are transferred from the Centre to the States through the following three sources –
  1. Finance Commission;
  2. NITI Aayog previously
  3. Planning Commission;
  4. Discretionary grants.
  • Since planning the contribution of the Centre to the State resources has been rising continuously. 
  • The share of these transfers in aggregate expenditure of the State governments has varied between 35 percent and 45 percent.
  • The growing transference of resources from the Centre to the States is evidence of –
  1. Increasing integration between the Central and State finance;
  2. Helpless dependence of States on the Centre;
  3. Growing power and interference of the Centre in the affairs of the State.
  • Among the taxes, the States' share of Union excise duties has been showing the largest rise. This is due to the increase in the number of items in the list of divisible excise duties. 
  • The States' share of taxes and duties as a whole has been expanding due to the increasing yields of various taxes also.
  • The large increase in grants from the Centre indicates the growing revenue requirements of States. Loans have registered only a modest increase.


Finance Commission

  • The Finance Commission (FC) is a quasijudicial body provided for under the provision of Article 280 of the Constitution. 
  • The President of India is required to appoint the Commission every five years or earlier for the specific purpose of devolution of non-plan revenue resources.
  • The functions of the FC are to make recommendations to the President in regard to the following :
  1. The distribution of net proceeds of taxes to be shared between the Union and the States and the allocation of shares of such proceeds among the States;
  2. The principles which should govern the payment of the union grants-in-aid to the revenues of the States;
  3. The continuance or modification of any agreement entered into between the Centre and any of the States; and
  4. Any other matter concerning financial relations referred to it.
  • The Finance Commissions have so far been appointed by the government since the inauguration of the Constitution in 1951. 
  • The recommendations of the Finance Commissions can be grouped under three heads– division and distribution of income tax and other taxes, grants-in-aid and Centre's loans to States.
  • The appointment of a Finance Commission at intervals of five years or less has great significance for the financial relations between the Union and the States. 
  • Periodical examination of the division of resources and suitable modifications in it imparts a degree of flexibility to the finance of both the Centre and the units. 
  • The flexibility is of great value in these days of changing needs and resources. 
  • The planned development of the country involves growing expenditure and therefore, larger revenues, and an elastic system of finance is a great necessity.
  • The Constitution provides resi-ouary powers to the Centre. The Indian Constitution makes a clear division of fiscal powers between the Centre and the State Governments.


The List I of Seventh schedule of Indian Constitution enlists the union taxes which are as follows:

  • Taxes on income other than agriculture income.
  • Corporation tax.
  • Custom duties.
  • Excise duties except on alcoholic liquors and narcotics not contained in medical or toilet preparation.
  • Estate and succession duties other than on agricultural land.
  • Taxes on the capital value of assets except agricultural land of indi-viduals and companies.
  • Rates of stamp duties on financial documents.
  • Taxes other than stamp duties on transactions in stock exchanges and future markets.
  • Taxes on sales or purchases of newspapers and on advertisements therein.
  • Taxes on railway freight and fares.
  • Terminal taxes on goods or passengers carried by railways, sea or air.
  • Taxes on the sale or pur-chase of goods in the course of inter-state trade.


List II of Seventh schedule enlists the taxes which are within the jurisdiction of the states :

  • Land revenue.
  • Taxes on the sale and purchase of goods, except newspapers.
  • Taxes on agricultural income.
  • Taxes on land and buildings.
  • Succession and estate duties on agricultural land.
  • Excise on alcoholic liquors and narcotics.
  • Taxes on the entry of goods into a local area.
  • Taxes on the consumption and sale of electricity.
  • Taxes on mineral rights (subject to any limitations imposed by the Parliament).
  • Taxes on vehicles, animals and boats.
  • Stamp duties except those on financial documents.
  • Taxes on goods and passengers carried by board or inland waterways.
  • Taxes on luxuries including entertainments, betting and gambling.
  • Tolls.
  • Taxes on professions, trades, callings and employment.
  • Capitation taxation.
  • Taxes on advertisements other than those contained in newspapers.

Apart from taxes levied and collected by the states, the constitution has provided for the revenues for certain taxes on the union list to be allotted, partly or wholly to the states. These provisions fall into various categories:

  • Duties which are levied by the union government but are collected and appropriated by the stales. These include stamp duties, excise duties on medical preparations containing alcohol or narcotics.
  • Taxes which are levied and collected by the union, but the entire proceeds of which are assigned to the states, in proportion determined by the Parliament. These  include:
  1. Succession and Estate duty.
  2. Terminal taxes on goods and passengers.
  3. Taxes on railway freight and fares.
  4. Taxes on transactions in atock exchanges and future markets.
  5. Taxes on sale and purchase of newpapers and advertisements therin.


Fourteenth Finance Commission Recommendations

  • Article 280 of the Constitution of India requires the constitution of a Finance Commission every five years, or earlier.
  • For the period 1st April, 2015 to 31st March, 2020 the 14th Finance Commission (FFC) was constituted by the orders of President on 2nd January, 2013.
  • The FFC was constituted under the chairmanship of Dr. Y.V. Reddy, former Governor of RBI. Ms. Sushma Nath, Dr. M. Govinda Rao, Dr. Sudipto Mundle and Prof. Abhijit Sen (Past time) were the other members of the commission.
  • With regard to vertical distribution, FFC has recommended that the States’ share in the net proceeds of the Union tax revenues be 42%.
  • The recommendation of tax devolution at 42% is a huge jump from the 32% recommended by the 13th Finance Commission.
  • As compared to the total devolutions in 2014-15 the total devolution of the States in 2015-16 will increase by over 45%.
  • In recommending horizontal distribution, the FFC has used broad parameters of population (1971) and changes of population since, income distance, forest cover and area.
  1. Population is the population of the State as per the 1971 census. 
  2. Demographic change are changes in population since 1971. 
  3. Income Distance is computed by calculating the difference between 3 years average (2010-11 to 2012-13) GSDP for each State with respect to the State with highest per capita GSDP. 
  4. Forest Cover has been used as there is an opportunity cost in terms of area not available for other economic activities. 
  5. Area has a floor limit at 2% for smaller States in deciding the horizontal devolution. 
  • Tourteenth FFC has recommended distribution of grants to States for local bodies using 2011 population data with weight of 90% and area with weight of 10%.
  • The grants to States will be divided into two, a grant to duly constituted Gram Panchayats and a grant to duly constituted Municipal bodies, on the basis of rural and urban population.
  • FFC has recommended grants in two parts; a basic grant, and a performance grant, for duly constituted Gram Panchayats and municipalities. 
  1. The ratio of basic to performance grant is 90:10 with respect to Panchayats and 80:20 with respect toMunicipalities.
  2. FFC has recommended out a total grant of Rs. 2,87,436 crore for five year period from 1.4.2015 to 31-3-2020. 
  3. Of this the grant recommended to Panchayatas is Rs. 2,00,292.20 crores and that to municipalities is Rs. 87,143.80 crores.
  4. The transfers in the year 2015-16 will be Rs. 29,988 crores.
  5. FFC has recommended that up to 10 per cent of the funds available under the SDRF can be used by a State for occurrences which State considers to be ‘disasters’ within its local context and which are not in the notified list of disasters of the Ministry of Home Affairs.


Sarkaria Commission Recommendations

  1. The commission did not find any need for drastic change in the Constitution.
  2. The commission does not set any justification for major modification in the basic structure of financial relations between the Centre and the States.
  3. It favoured amendments to provide for sharing corporate tax and levy of consignment tax and on advertisement and broadcasting.
  4. There should be no limiting of the powers of the union.
  5. The various suggestions asking for transfer of subjects of the State or concurrent list have been rejected.
  6. A process of consultation be initiated by the Centre on all concurrent subjects.
  7. The suggestion to provide for levy of additional sales in lieu of excise duty has been rejected.
  8. Rejected almost all the suggestions to shift the location powers of the Centre to the States.
  9. The National Development Council should maintain its separate identity but should have a formal status and its duties should be reaffirmed through a Presidential order under Art. 263 of the Constitution. 
  10. The NDC should be renamed as the National Economic and Development Council (NEDC).


NITI Aayog

  • 65-year-old Planning Commission has been dissolved and a new institution named NITI Aayog has been constituted by the National Democratic Alliance (NDA) government. 
  • Like Planning Commission the newly established NITI Aayog will also be chaired by the Prime Minister. 
  • NITI Aayog or National Institution for Transforming India will serve as a government think tank and is meant to reflect changes required in India’s governance structures and provide a more active role for the state governments in achieving national objectives. 
  • The newly constituted institution will provide governments at the central and state levels with strategic and technical advice across the spectrum of policy making.
  • As per official declaration, this institution includes matters of national and international import on the economic front, dissemination of best practices from within the country as well as from other nations, the infusion of new policy ideas and specific issue-based support. 
  • NITI Aayog will be headed by the Prime Minister, who will be the Chairperson. 
  • The Prime Minister will appoint a vice-chairperson and a chief executive officer (CEO). 
  • The CEO will be appointed for a fixed tenure; it will be a secretary-level position.
  • The organization will have full-time members and up to two part-time members from leading universities, research organizations and other relevant institutions.
  • It will also have up to four   ex-officio members from the Union council of ministers who will be nominated by the Prime Minister.

The NITI Aayog will workards the following main Objectives :

  1. To evolve a shared vision of national development priorities, sectors and strategies with the active involvement of States in the light of national objectives.
  2. To foster cooperative federalism through structured support initiatives and mechanisms with the States on a continuous basis, recognizing that strong States make a strong nation.
  3. To develop mechanisms to formulate credible plans at the village level and aggregate these progressively at higher levels of government.
  4. To ensure, on areas that are specifically referred to it, that the interests of national security are incorporated in economic strategy and policy.
  5. To design strategic and long term policy and programme frameworks and initiatives, and monitor their progress and their efficacy.
  6. To create a knowledge, innovation and entrepreneurial support system through a collaborative community of national and international experts, practitioners and other partners.
  7. To offer a platform for resolution of intersectoral and interdepartmental issues in order to accelerate the implementation of the development agenda.
  8. To focus on technology upgra-dation and capacity building for implementation of progammes and initiatives. 
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