Revision Notes: Centre-State Financial Relations & Inter-State Relations UPSC Notes | EduRev

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Centre-State Financial Relations 

Part XII, Chapter I of Constitution deals with finance. The success of a federal system depends on the proper exercise of respective powers by the Union and the constituent states. Such powers and functions are, however, unthinkable in the absence of adequate financial resources. Unlike other federations, the Indian Constitution has tried to demarcate the area of taxation as completely as possible. Every possible tax has been assigned either to the state or to the Union. Yet overlapping and multiple taxation does occur, leading to strains in the Centre-state relationship. The Constitution tries to prevent finances from becoming a bone of contention between the Centre and states.
 Art. 265 says that no tax can be levied or collected except by the authority of law. In other words, no tax can be imposed by an executive order.

Distribution of Legislative Powers to Levy Taxes 

The legislative power to make laws for imposing a tax is divided between the Union and the states by means of specific entries in the Union and State Legislative Lists in the Seventh Schedule of the Constitution. The Centre can levy taxes on the 12 items of the Union List (82 to 92A). Similarly, the State list contains 19 items on which states are empowered to collect taxes (45 to 63). There is no concurrent list in matters of tax legislation. The residuary powers in taxation (as is general legislation) vests with Parliament (item no 97). Gift and expenditure taxes are governed by this residuary power. The taxes levied and collected by the Union form the revenue  of the Union Government. Similarly, taxes levied and collected by the states go into the states' revenue account.

Distribution of Taxes 

The tax revenue is distributed between the Union and the States as follows.
(i) Taxes belonging to the Union exclusively: 1. Customs, 2. Corporation Tax, 3. Taxes on capital value of assets of individuals and companies,  4. Surcharge on income tax, etc. 5. Fees in respect of matters in the Union List (List I). 

(ii) Taxes belonging to the States exclusively : 1. Land Revenue, 2. Stamp duty except in documents included in the Union List, 3. Succession duty, Estate duty, and Income tax on agricultural land, 4. Taxes on passengers and good carried on inland waterways, 5. Taxes on lands and buildings, mineral rights, 6.
 Taxes on animals and boats, on road vehicles, on advertisements, on consumption of electricity, on luxuries and amusements, etc, 7. Taxes  on entry of goods into local areas, 8. Sales Tax, 9. Tolls, 10. Fees in respect of matters in the State List, 11. Taxes on professions, trades, etc. not exceeding Rs. 2,500 per annum (List II). 

(iii) Duties levied by the Union but collected and appropriated by the States: Stamp duties on bills of Exchange, etc. and Excise duties on medicinal and toilet preparations containing alcohol, though they are included in the Union List and levied by the Union, shall be collected by the States insofar as leviable within their respective territories, and shall form part of the States by whom they are collected (Article 268). 

(iv) Taxes levied as well as collected by the Union, but assigned to the States within which they are leviable : (i) Duties on succession to property other than agricultural land. (ii) Estate duty in respect of property other than agricultural land . (iii) Terminal taxes on goods or passengers carried by railway, air or sea. (iv) Taxes on railway fares and freights. (v) Taxes on sales of and advertisements in newspapers. (vi) Taxes on the sale, or purchase of goods, other than newspapers, where such sale or purchase takes place in the course of inter-State trade or commerce. (vii) Taxes on inter-State consignment of goods (Article 269). 

(v) Taxes levied and collected by the Union and distributed between Union and the States: Certain taxies shall be levied as well as collected by the Union, but their proceeds shall be divided between the Union and the states in a certain proportion, in order to effect an equitable division of the financial resources. These are (i) Taxes on income other than on agricultural income (Article 270). (ii) Duties of excise as are included in the Union List excepting medicinal and toilet preparation may also be distributed, if Parliament by law so provides (Article 272). 

(vi) The principal sources of non-tax revenues of the Union: Are the receipts from Railways; Posts and Telegraph; Broadcasting; Opium; Currency and Mint; Industrial and Commercial Undertakings of the Central Government relating to the subject over which the Union has jurisdiction. Of the industrial and commercial undertakings relating to Central subjects may be mentioned the Industrial Finance Corporation; the Air Corporations; industries in which the Government of India has made investments, such as the Sindri Fertilisers and Chemicals Ltd., the Hindustan Shipyard Ltd., the Indian Telephone Industries Ltd. 

(vii) The State have their receipts from forests., irrigation and commercial enterprises (like electricity, road transport) and industrial undertakings (such as soap, sandalwood, iron and steel in Karnataka, paper in Madhya Pradesh, milk supply in Bombay, deep-sea fishing and silk in West Bengal).

Grants and Loans 

Besides the devolution of revenues, from different taxes, the Union meets the financial needs of the States: (i) by making grants-in-aid to State revenues and other grants; and (ii) by giving loans Accordingly, the Constitution provides for grants to be made every year to the states selected by Parliament on the recommendation of the Finance Commission.

Borrowing Power 

To augment the financial resources, the constitution permits both the Union and state governments to borrow money under certain conditions. Art. 292 vests the Union government with the power to borrow money on the security of the Consolidated Fund of India either within or outside the country, subject to any limitation imposed by Parliament. Till now, no such limits have been imposed by Parliament.

Similarly, Art 292 also permits State governments to borrow money on the security of the Consolidated Fund of the State. But a state cannot borrow from outside India. The government of India may itself extend a loan to a State under the laws passed by Parliament. The State Legislature can impose limitations on the borrowing powers of that state government.

Consolidated Fund 

Art. 266 provides for a Consolidated Fund of India and of the state subject to assignment of certain taxes to the States, all revenues received by the Government of India, all loans caused by the government and all moneys received by that government in repayment of loans shall form one consolidated fund to be called "the Consolidated Fund of India". All other Public moneys received by or on behalf of the Government of India shall be credited to the Public Account of India.

Contingency Fund

Art. 267 empowers Parliament and Legislature of a State to create a Contingency Fund" for India or for States, as the case may be.The Contingency Fund for India has been constituted by the Contingency Fund of India Act, 1950. The fund will be at the disposal of the executive to enable advances to be made, from time  to time, for the purpose of meeting unforeseen expenditure, pending authorisation of such expenditure by the Legislature by supplementary, additional or excess grants. The amount of the Fund is subject to be regulated by the appropriate Legislature.

Finance Commission

Apart from demarcating the taxes and their distribution between the Union and the states, the Constitution has also created a quasi-judicial body for the periodical review of the arrangement. The Finance Commission performs this vital role of reviewing the distribution of taxes and other allied issues.

Art. 280, read with the Finance Commission (Miscellaneous Provisions) Act of 1951, amended in 1955, deals with the constitution of the Finance Commission. The Commission has to be constituted by the President after every five years. The Commission is to consist of a chairman and four members. Parliament is empowered to determine the qualification and mode of appointment of members of the Commission.

The chairman must be a person with 'experience in public affairs'. The four other members are selected from among the persons who:

  • are or have been or are qualified to be appointed as High Court Judges; or 
  • have special knowledge of the finance and the accounts of the government; or 
  • have had wide experience in financial matters and in administration; or 
  • have special knowledge of economics 

The Finance Commission is obliged to recommend to the President : (i) distribution of the net proceeds of tax between the Union and the State and allocation between the States of the respective shares of such proceeds; (ii) The principles which should govern the grants-in-aid out of the Consolidated Fund of India; (iii) The measures needed to augment the Consolidated Fund of a State to supplement the resources of the Panchayats in the State; (iv) The measures need to augment the Consolidated Fund of a State to supplement the resources of the Municipalities in the State; and (v) Any other matters referred to by the President in the interest of sound finance.
 The  reference to the Finance Commission is made under two terms: compulsory and discretionary.

Art. 270 makes it mandatory to divide taxes on income other than the agricultural income between the union and the States. The President, after considering the recommendations of the Finance Commission, prescribes by order, the  percentage and the manner of distribution.

The Finance Commission may recommend principles governing the distribution of tax of excise among the states as prescribed under Art 272.

The Finance Commission under Art. 280 (3) (b) makes recommendation relating to the principles of grants-in aid. These grants are to be provided by the law of Parliament. But Parliament may exclude grants to the states which,according to the Finance Commission, do not need any such assistance.

Finally, the President under Art. 280 (3) (c) may require the advice of the Finance Commission on a matter by virtue of its relation to sound finance.
 The First Finance Commission was constituted in 1951 with Neogy as its chairman. It submitted its report in 1953. Till now eleven Finance Commissions have been constituted.

Financial Relations During Emergency

The normal financial relation between the Union and the States (under Art. 268-279) is liable to be modified in different kinds of emergencies.

While a proclamation of Emergency (Art. 352) is in operation, the President may by order direct that, for a period not extending beyond the expiration of the financial year in which Proclamation ceases to operate, all or any of the provisions relating to the division of taxes between the Union and the State and grants-in-aid shall be suspended (Art. 354). As a consequence the States will have to depend on their narrow resources from the revenues under  the State List.
 While a Proclamation of Financial Emergency (Art.360) is made by the President, it shall be competent for the Union.
 (i) To give directions to the States to observe such cannons of financial property as may be specified in the communication;
 (ii) To instruct State Governments that the salaries and allowances of all public servants including judges be reduced in the specified manner;
 (iii) To reserve for the consideration of the President all money bills and financial bills, after they are passed by the legislature of the state.
 Art. 360 has, thankfully not been used till today.

Central Control Over Finances 

The Union Government exercises control over the finances of states through constitutional and extra-constitutional agencies. Under Art. 148, there shall be a Comptroller and Accountant General of India, appointed by the President. He shall prescribe the manner in which the accounts of the Union and states are to be kept. He shall also review the cases of financial impropriety. Thus, through the CAG, the Union Government exercises control over state finances as a constitutional obligation.

The extra-constitutional and extra-statutory agency through which the Union government exercises control over the finances of the state is the Planning Commission. It has no counterpart in the state, so exercises optimum powers in regulating state finances. Formed by a simple resolution by Jawaharlal Nehru, in 1950, the Planning Commission officially functions as an advisory body. Since the states depend on the Centre for financial assistance, the advice becomes too imposing to be ignored. The Planning Commission decides what is to be done and when— both at the Centre and the State levels–with regard to the economic uplift of the country.




Operational During



K.C. Neogy




K.S. Santhanam




A.K. Chanda




Dr. P.V. Rajamanar




Mahavir Tyagi




K.Brahmananda Reddy




J.M. Shelat




YB. Chavan




N.K.P. Salve




K.C. Pant




A.M. Khusro






Thirt eenth2007Dr. Vijay L. Kelkar2010-2015
Fourteenth2013Dr. Y.V.Reddy2015-2020

Inter-State Relations

The states are sovereign units in their independent existence vis-a-vis the Union and other states.
 But for a healthy federation, it is essential that they cooperate with each other. Conflicts of interests are bound to crop up. To maintain the strength of the Union, it is essential that there should be adequate provisions for prevention of such disputes by consultation and joint action; and when they occur, for their judicial determination and settlement by extrajudicial bodies. All federal constitutions, therefore, lay down certain rules of comity which the units are required to observe in their dealings with each other.
 These rules and agencies relate to such matters as—

  • recognition of the public acts, records and proceedings of each other; 
  • extra-judicial settlement of disputes; 
  • coordination between the states, and 
  • freedom of inter- state trade, commerce and intercourse.

Recognition of public Acts

Despite the confined jurisdiction of each state in its own territory [(Art. 162,245 (1)], and the possibility of refusal of records or order of one state by another, the Constitution provides for the honour and recognition of public acts or records or order of one state by the others. It candidly expresses that —

'Full faith and credit shall be given throughout the territory of India to public acts, records and the judicial proceedings of the Union and every state.[Art. 261 (1)].

This means that duly authenticated copies of statues, or statutory instruments, judgements or orders of one state are to be given recognition and effect by other states. Parliament has power to legislate as to the mode of proof of such acts and records or the effects there of [(Art. 261 (2)].

Extra-Judicial settlement of Disputes

Though a federal Constitution involves the sovereignty of the units, disputes may arise over clash of interest. To avoid such disputes, and resolve it, adequate provisions exist for judicial determination of the disputes by extra-judicial agencies. Art 131 provides for judicial determination of disputes between the states by vesting the Supreme Court with exclusive jurisdiction in the matters. Art 262 provides for adjudication of one class of such disputes by extra judicial tribunal. And Art. 263 provides for the prevention of inter-state disputes by investigation and recommendation by an administrative body.
 Thus —

1. Parliament may, by law, provide for the adjudication of any dispute or complaint with respect to the use, distribution and control of the waters of, or in, any inter-state river or river valley and also provide for the exclusion of the jurisdiction of all courts, including the Supreme Court to entertain such disputes. (Art. 262).
 In exercise of this power, Parliament has enacted the Inter-State Water Dispute Act, 1956, providing for the constitution of an ad hoc tribunal for the adjudication of any dispute arising between two or more states with regard to the waters of any inter-state river or river valley. 

2. The President can establish an Inter-State Council for enquiring into and advising upon interstate disputes if at any time it appears to him that public interest would be reviewed by establishment of such Council. (Art. 263 (a)).  Thus an Inter-State Council was constituted in 1990 by a presidential order.

Coordination Between States

The President's power to set up an Inter-State Council may be exercised for not only advising upon disputes, but also to investigate and discuss subjects in which some or all the President has already constituted the Central Council of Health, Central Council of Local Self-Government, Central Council of Indian Medicine, Central Council of Homeopathy.

A few advisory bodies to advise upon matters of inter-state disputes have been established by the statues of Parliament.

Zonal Councils

Zonal Councils have been established by the States Reorganisation Act, 1956, to advise on matters of common interest to each of the five zones into which the territory of India has been divided. These zones are: northern, southern, western and central.
 Zonal Councils have been introduced with a view to secure cooperation and coordination between States, Union Territories and the Union, particularly, in respect of social and economic planning. The object of these Councils, as Nehru envisaged it, is to 'develop a habit of cooperative working'. The presence of Union Ministers, nominated by the Union Government, in each of these Councils (and the Chief Ministers of the State concerned) also furthers coordination and national integration through an extraconstitutional advisory organisation, without undermining the autonomy of the states.

Each Zonal Council consists of the Chief Minister and two other ministers of each of the state, and or the administrator in case of a Union Territory. There is a provision of joint meeting of two or more Zonal Councils. The Union Home Minister is the convenor chairman of all Zonal Councils.

Zonal Councils discuss matters of common concern to the states and territories comprised in each Zone, such as economic and social planning, border disputes, inter-state transport, matters arising out of the reorganisation of the states and the like and give advice to the governments of the states concerned as well as the Government of India.

The constitution of the different zones is as follows:
 (i) Central Zone : Uttar Pradesh and Madhya Pradesh
 (ii) Northern Zone : Haryana, Himachal Pradesh, Punjab, Rajasthan, Jammu and Kashmir, Delhi and Chandigarh.
 (iii) Eastern Zone: Bihar, West Bengal, Orissa and Sikkim.
 (iv) Western Zone : Gujarat, Maharashtra, Goa, Dadra and Nagar Haveli, Daman and Diu.
 (v) Southern Zone : Andhra Pradesh, Karnataka, Kerala, Tamilnadu, Pondicherry.

There is also the North Eastern Council, set up in 1971, to deal with the common problems of Assam, Meghalaya, Manipur, Nagaland, Tripura, Arunachal Pradesh and Mizoram. The headquarters of NEC is in Guwahati.

The River Boards Act, 1956 

The Act provides for the establishment of a River Board to advise the governments on the regulation
 of development of an inter-state river or river valley.

The Water Disputes Act, 1956 

The Act provides for the reference of inter-state river dispute for the arbitration by a Water Disputes Tribunal, whose awards would be final, according to Art. 262 (2).

Freedom of Inter-State Trade And Commerce 

The great problem of any federal structure is to minimise inter-state barriers as much as possible so that the people may feel they are members of one nation though they may, individually, be residents of different units of the Union. One means to achieve this object is to guarantee to every citizen the freedom of movement and residence throughout the country. Our Constitution guarantees this right under Art. 19(1)(d)-(e).

No less important is the freedom of movement or passage of commodities and of commercial transaction between one part of the country and another.
 The progress of the country as a whole requires free flow of commerce and intercourse as between different parts, without any barrier. This is particularly essential in a federal system. This freedom is sought to be secured by Art. 301-307 contained in part XIII of the Constitution. These provisions are not confined to inter-state freedom but include inter-state freedom as well. In other words, subject to the exceptions laid down in part XIII, no restrictions can be imposed upon the flow of trade, commerce and intercourse, not only as between one state and another but as between any two points in the territory of the country whether any state border has been crossed or not. Art. 301 thus declares:

'Subject to the other provisions of this Part, trade, commerce intercourse throughout the country shall be free'. The limitations imposed upon this freedom by the other provisions of Part XIII are —
 (i) Non-discriminatory restrictions may be imposed by Parliament, in the public interest (Art. 302).
 By virtue of this power, Parliament has enacted the Essential Commodities Act, 1955 which empowers the Central Government, ' in the interest of general public,' to control the production, supply and distribution of certain 'essential commodities' such as coal, cotton, iron and steel, petroleum, etc.
 (ii) Even discriminatory or preferential provisions may be made by  Parliament for dealing with a scarcity of goods arising in any part of the country (Art. 302(2)).
 (iii) Reasonable restrictions may be imposed by State 'in the public interest' [Art 304(b)]. This is subject to the assent of the President. Secondly, under Art. 303 (1), no discrimination may be made by Parliament by according preference to one state.
 (iv) Non discriminatory taxes may be imposed by a state on goods imported from other states or Union Territories, similarly as on interstate goods [Art. 304(4)]
 (v) The Union or a state legislature has the power to make laws under Art. 19(6) (ii) to restrict spheres of business activity to its own bodies, and exclude private enterprise in it, fully or partly.

In Automobile Transport Ltd. vs State of Rajasthan, Justice Das held that the main purpose of art. 301 is to ensure both internal and inter-state trade, commerce and intercourse. Again in Atiabari Tea Co. vs State of Assam, justice Gajendra Gadkar maintained that the purpose of the whole of part XIII is to help attain fiscal and economic integrity of the country.

Centre-State Relations — Over Centralisation 

The Indian constitution makes the Centre stronger than the States. There is provision for Union control both over state administration and legislation. The stronger position of the Centre is reflected in the power of Parliament to create new states, to alter the boundaries of existing states and even to abolish a state by ordinary legislative procedure, without recourse to constitutional amendment. Under a proclamation of emergency, Parliament is empowered "to make laws for the whole or any part of the territory of India with respect to any of the matters enumerated in the state list. The President, if advised by the Governor, that "the government of the state cannot be carried on in accordance with the provision of this constitution," may by proclamation assume all executive functions to himself and declare the powers of the State Assembly to be under the authority of Parliament. In addition the Rajya Sabha may by two-thirds vote resolve that it is "necessary or expedient" that Parliament make laws for a temporary period with respect to any matter on the state list. Also since state representation in the Rajya Sabha is unequal, larger states have the power to transfer a subject from State to Union jurisdiction if opposition parties should gain control of some of the smaller States. A variety of other articles also reveals the constitutional imbalance between the Union and States; the amending process, the single judicial system, the all-India services, the single election commission and the provision for reservation of
 certain state bills for Presidential assent.

From 1947 to 1967 and from 1971 to 1977 and thereafter from 1980 to 1989 the Congress party rule (single party dominance), both at the Centre factor responsible for centralisation and the erosion of the state autonomy. Primarily it weakened the will of state governments for autonomy. It created a feeling among the state leaders that it would be best for them to abide by the decisions of the Central leaders who could be credited with having more knowledge and more ability and who commanded more prestige in the country as a whole.

Moreover, the distribution of revenue resources has been in favour of the Centre. Under the Constitution taxes like income tax, corporation tax, excise duties and customs which have both a national and inter state base have been made in for the Centre.
 Taxes like _ those on land, buildings, sales taxes, taxes on motor vehicles which have a local base have been made over to states. The Central taxes are not only more lucrative but also grow the growth in national economy but the taxes of states are less lucrative and less elastic. Besides Centre has foreign aid and deficit financing at its disposal 

Committees For Reforming The Relations 

Setalvad Committee 

An Administrative Reforms Commission (ARC), appointed by the government, constituted a Study Team under M.C. Setalvad in 1966 to examine the centre-state relations. The Study Team submitted its report in 1968 in which it recommended for greater autonomy of the States without amending the Constitution.

Rajamannar Committee 

The Rajamannar Committee was constituted by the Tamil Nadu government in 1969, under the chairmanship of P.V. Rajamannar, a retired Chief Justice of Madras High Court. The terms of reference of the Committee were to examine the entire question regarding the relationship that should exist between the Centre and the States in a federal set-up and to suggest amendments to the Constitution so as to "secure utmost autonomy to the states." The committee presented its report on 29 May, 1971. Some of the important recommendations of the Committee were —
 (i) The transfer of several subjects from the Union and Concurrent Lists to the State List;
 (ii) The residuary power of legislation and taxation should be vested in the State Legislature;
 (iii)  An Inter-State Council comprising Chief Ministers of all the states or their nominees with the Prime Minister as its chairman should be set up immediately;
 (iv) The abolition of the existing Planning Commission and its replacement by a statutory body, consisting of scientific, technical, agricultural and economic experts, to advise the states which should have their own Planning Boards;
 (v) Deletion of those articles of the Constitution empowering the Centre to issue directives to the states and to take over the administration in a state;
 (vi) Article 312 should be so amended as to omit the provision for the creation of any new AllIndia cadre in future.

The Central government rejected the Committee's recommendations.

Sarkaria Commission 

The Sarkaria Commission was set up in March 1983 under the chairmanship of Justice R.S.
 Sarkaria, a retired Judge of the Supreme Court. It was constituted to examine and suggest reforms for an equitable distribution of powers between the Centre and the States. It submitted its report in January 1988.
 The Commission made 247 recommendations to improve centre-state relations, besides suggesting 12 amendments to the Constitution and 20 new legislations. The Commission recommends—
 (i) Before issuing directions to a state under Arti-
 cles 256 and 257, the Union should explore the possibilities of settling points of conflict by all other available means;
 (ii)  The Governor of a state should be a nonpolitical person appointed with the concurrence of the Chief Minister;
 (iii) Article 356 should be used very sparingly, in extreme cases, as a measure of last resort;
 (iv) Before deploying Union armed and other forces in a state in aid of the civil power, it is desirable that the State Government should be consulted;
 (v) By an appropriate amendment of the Constitution, the net proceeds of Corporation Tax may be made permissibly shareable with the states;
 (vi) Art. 258 (the centre's right to confer authority to the states in certain matters) should be liberally used by the centre;
 (vii) High Court Judges should not be transferred against their will (partially overriding a Supreme Court judgement);
 (viii) Inter-state Council (without which interstate disputes are intractable) under Art. 263 should be set up as a permanent body to deal with subject other than socio-economic development;
 (ix) The State's say in the Concurrent List should be strengthened and the Centre's hold on the Union List should be loosened., 

The Commission has completely ignored the Anandpur Sahib Resolution which advocates States autonomy.

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