{"id":3878,"date":"2026-08-22T08:33:58","date_gmt":"2026-08-22T08:33:58","guid":{"rendered":"https:\/\/kingmakersiasacademy.com\/current-affairs\/?p=3878"},"modified":"2026-08-22T08:44:26","modified_gmt":"2026-08-22T08:44:26","slug":"fiscal-federalism-and-the-changing-dynamics-of-centre-state-finances","status":"publish","type":"post","link":"https:\/\/kingmakersiasacademy.com\/current-affairs\/fiscal-federalism-and-the-changing-dynamics-of-centre-state-finances\/","title":{"rendered":"Fiscal Federalism and the Changing Dynamics of Centre-State Finances"},"content":{"rendered":"<h1><\/h1>\n<blockquote>\n<h5><strong>UPSC Syllabus: <\/strong><strong>GS Paper III \u2013 Indian Economy:<\/strong> Indian Economy and issues relating to planning, mobilisation of resources, growth, development and employment.<\/h5>\n<\/blockquote>\n<h3>Why in News?<\/h3>\n<p>The Centre\u2019s fiscal outlook is facing geopolitical and revenue-related risks, bringing renewed attention to the state of <strong>fiscal federalism in India<\/strong>.<\/p>\n<p>Fiscal federalism is influenced not only by the percentage of taxes devolved to States through the Finance Commission, but also by the <strong>composition of the Union&#8217;s tax revenues and the growing reliance on cesses and surcharges<\/strong>.<\/p>\n<h3>What is Fiscal Federalism?<\/h3>\n<p>Fiscal federalism refers to the distribution of <strong>financial powers, taxation responsibilities and expenditure functions between different levels of government<\/strong>.<\/p>\n<p>In India, the Union generally has greater revenue-raising capacity, while States carry substantial expenditure responsibilities in areas such as <strong>health, education, agriculture and local development<\/strong>. This creates a vertical fiscal imbalance that is addressed partly through tax devolution and grants.<\/p>\n<h3>Role of the Finance Commission<\/h3>\n<p>The Finance Commission plays a central role in maintaining fiscal balance between the Centre and the States.<\/p>\n<ul>\n<li><strong>Article 280<\/strong> mandates the Finance Commission to recommend the distribution of the net proceeds of Union taxes between the Union and the States.<\/li>\n<li>The <strong>15th Finance Commission<\/strong> retained the States&#8217; share at <strong>41% of the divisible pool for 2021\u201326<\/strong>.<\/li>\n<li>This constitutes <strong>vertical devolution<\/strong>, addressing the imbalance between the revenue capacities and expenditure responsibilities of the two levels of government.<\/li>\n<li>The Finance Commission also undertakes <strong>horizontal devolution<\/strong>, distributing the States&#8217; share among individual States using criteria such as income distance, population, area, forest and ecology, demographic performance and tax effort.<\/li>\n<\/ul>\n<h3>Why Does the Composition of Central Tax Revenue Matter?<\/h3>\n<p>A crucial aspect of fiscal federalism is the distinction between <strong>shareable taxes and non-shareable levies<\/strong>.<\/p>\n<ul>\n<li><strong>Article 270<\/strong> provides for the distribution of specified Union taxes between the Union and States.<\/li>\n<li><strong>Article 271<\/strong> permits the Union to impose a surcharge, with the entire proceeds accruing to the Union.<\/li>\n<li>Cesses imposed for specific purposes are also excluded from the divisible pool.<\/li>\n<\/ul>\n<p>Therefore, an increase in the Centre&#8217;s gross tax revenue does not necessarily translate into a proportional increase in resources available to States if the growth comes disproportionately from cesses and surcharges.<\/p>\n<h3>The Concern over Cesses and Surcharges<\/h3>\n<p>The proliferation of cesses and surcharges can reduce the effective resources available to States even when the States&#8217; nominal share of the divisible pool remains unchanged.<\/p>\n<p>The <strong>15th Finance Commission<\/strong> noted concerns regarding the impact of cesses and surcharges on resources available to States. The <strong>16th Finance Commission<\/strong> has also recorded concerns raised by several States regarding the declining share of the divisible pool in Gross Tax Revenue, along with proposals to include or cap cesses and surcharges.<\/p>\n<h3>Implications for Cooperative Federalism<\/h3>\n<p>The changing composition of Union tax revenues has wider implications for Centre-State relations:<\/p>\n<p><strong>1. Reduced fiscal autonomy<\/strong><br \/>\nStates may have less untied revenue to determine their own development priorities.<\/p>\n<p><strong>2. Vertical fiscal imbalance<\/strong><br \/>\nThe Union gains greater fiscal flexibility while States continue to shoulder substantial expenditure responsibilities.<\/p>\n<p><strong>3. Conditionality concerns<\/strong><br \/>\nGreater dependence on centrally sponsored schemes may restrict States&#8217; policy flexibility.<\/p>\n<p><strong>4. Inter-State tensions<\/strong><br \/>\nRevenue-rich and revenue-poor States may have differing perspectives on devolution, efficiency and redistribution.<\/p>\n<p><strong>5. GST dimension<\/strong><br \/>\nFollowing the introduction of GST, States have surrendered several independent indirect-tax handles, making predictable and adequate transfers increasingly important.<\/p>\n<h3>Why Does the Union Use Cesses and Surcharges?<\/h3>\n<p>Cesses and surcharges also serve legitimate fiscal purposes. They enable the Union Government to mobilise targeted resources for national priorities such as:<\/p>\n<ul>\n<li>Infrastructure<\/li>\n<li>Health<\/li>\n<li>Education<\/li>\n<li>Environmental programmes<\/li>\n<\/ul>\n<p>They also provide fiscal flexibility without permanently changing the Finance Commission&#8217;s devolution formula.<\/p>\n<p>Thus, while cesses and surcharges are <strong>constitutionally permissible<\/strong>, excessive dependence on them can weaken the spirit of fiscal federalism.<\/p>\n<h3>Way Forward<\/h3>\n<p><strong>1. Greater transparency<\/strong><br \/>\nProvide greater transparency regarding the purpose, collection and utilisation of cesses.<\/p>\n<p><strong>2. Reasonable ceiling<\/strong><br \/>\nConsider a reasonable ceiling on cesses and surcharges as a proportion of Gross Tax Revenue.<\/p>\n<p><strong>3. Broader divisible pool<\/strong><br \/>\nConsider transferring collections beyond such a ceiling to the divisible pool, as suggested by several States.<\/p>\n<p><strong>4. Strengthen untied devolution<\/strong><br \/>\nGreater emphasis should be placed on untied tax devolution rather than excessive reliance on conditional transfers.<\/p>\n<p><strong>5. Strengthen States&#8217; own revenues<\/strong><br \/>\nStates should improve their own-tax capacity through better GST compliance, property taxation and digital tax administration.<\/p>\n<p><strong>6. Institutional consultation<\/strong><br \/>\nThe GST Council, Inter-State Council and Finance Commission processes can be used to strengthen dialogue and cooperative fiscal decision-making.<\/p>\n<h3>Conclusion<\/h3>\n<p>Fiscal federalism cannot be assessed merely by asking <strong>\u201cWhat percentage of taxes is devolved?\u201d<\/strong> The more fundamental question is <strong>\u201cWhat proportion of the Union&#8217;s overall tax resources actually enters the divisible pool?\u201d<\/strong><\/p>\n<p>A healthy federation requires both <strong>adequate vertical devolution and a sufficiently broad divisible pool<\/strong>. The objective should be to preserve the Union&#8217;s fiscal capacity while ensuring that States have adequate, predictable and untied resources to fulfil their constitutional and developmental responsibilities.<\/p>\n<h3>UPSC Relevance<\/h3>\n<p><strong>PYQ Reference \u2013 UPSC CSE 2025<\/strong><\/p>\n<blockquote><p><strong>Marks:<\/strong> 15<\/p>\n<p>\u201cExamine the evolving pattern of Centre-State financial relations in the context of planned development in India. How far have the recent reforms impacted the fiscal federalism in India?\u201d<\/p><\/blockquote>\n<h6><a href=\"https:\/\/epaper.thehindu.com\/ccidist-ws\/th\/th_international\/issues\/200328\/OPS\/GF1GCU78N.1+GMVGE24QE.1.html\" target=\"_blank\" rel=\"noopener\"><strong>SOURCE: <\/strong><strong>The Hindu e-paper, <\/strong>Centre\u2019s fiscal outlook faces geopolitical, revenue risks<\/a><\/h6>\n<p>&nbsp;<\/p>\n<h3>Key Takeaway<\/h3>\n<p><strong>Fiscal federalism is not merely about the percentage of tax devolution; it is also about the size and composition of the divisible tax pool.<\/strong> A stronger fiscal federation requires adequate resources, greater transparency and meaningful Centre-State consultation.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>UPSC Syllabus: GS Paper III \u2013 Indian Economy: Indian Economy and issues relating to planning, mobilisation of resources, growth, development 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