Fiscal Federalism – UPSC GS2

Recent measures suggesting a concentration of power by the Centre:
  • Increasing monitory share of states in centrally sponsored schemes.
  • The terms of reference of 15th finance commission.
  • Imposition of demonetization without adequate consultation with the states.
  • The institutionalization of goods and services tax and the subsequent delay in transfer of GST compensation.
  • One nation one ration.
  • Banking regulation act 2020
  • Government of national capital territory amendment act, 2021
  • Draft electricity bill 2020
  • Dam safety Bill 2019
  • A large share of non-divisible pool taxes in form of cess in petrol tax and creating the Agriculture Infrastructure Development Cess has resulted in a situation where union government continues to get exclusive benefits of tax collection. This share has jumped from 12.67% in 2019- 2020 to 23.46% in 2020–2021. (#diagram Graph)
  • Union government issued a clarification that funding to chief ministers disaster relief funds will not be considered as CSR expenditure. This is in opposition to the case with PM – CARES.
What steps should be taken to resolve this situation?
  • It is time for the constitution of a committee like the Rajamannar committee to study centre-state relations.
  • As recommended by NCRCW, the state should demand the creation of an institutional framework to mandate and facilitate consultation between unions and the states in areas of legislation under concurrent lists.
  • Chief ministers should try to create forums for regular engagement rather than just during times of crisis. For example, Finance Minister Thomas Isaac rallied finance ministers from different states during the initial stages of discussion on the terms of reference of the 15th finance commission. This would be crucial for a discussion on which demands like the extension of GST compensation to 2027 and the inclusion of cess in the divisible pool of taxes.

Issues over the implementation of 14th Finance Commission report

  • The 14th Finance Commission report in 2015 promised devolution of more finances to the States.
  • As part of the process, States would have new responsibilities, especially in the social sector.
  • The Goods and Services Tax (GST) regime was also justified as a grand bargain that would eventually leave all States better off.
  • In reality, tax devolution to States has been consistently below 14th Finance Commission projections.
  • One reason for this has been the economic slowdown, and lower-than-expected GST collections.
  • Payments to the States have been delayed as well.
  • There is a ₹6.84 lakh crore gap between what the 14th Finance Commission promised to States and what they have received.
  • States undertook programmes and projects spending 46% more than the Central Government; today the figure is 64%.
  • Despite spending less than the states the Centre’s fiscal deficit exceeds the consolidated State deficit by 14%.

Need to revisit the FRBM provisions

  • Due to pandemic, the fiscal deficit for States, collectively, is inevitably going to breach the projection of 2.04%.
  • As per provisions of the Fiscal Responsibility and Budget Management (FRBM) Act, the GSDP can actually accommodate a fiscal deficit of 3%.
  • Now, post-pandemic, this limit will be crossed.
  • The FRBM has an “escape clause” that allows for a one-time relaxation of the fiscal deficit threshold upto 0.5% in a time of exigency.
  • The escape clause has been utilised by the Centre but it has proven woefully insufficient in addressing the current crisis.
  • Fiscal policymakers and technocrats agree that the rigidity of the FRBM has to be revisited.
  • It should allow for greater flexibility and consultation as to when and how the “escape clause” can be applied.
  • The Centre has gone in for subjective interpretation, imposing conditions that are outside the scope of the FRBM.


Centre government needs to be more considerate of the financial woes of the State and try to deliver on the recommendations of the 14th Finance Commission report.
Related Questions:
  • Fiscal tensions have emerged as  a new front in the Centre-State relations. Suggest the steps the Centre should take to address it.

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