IAS Gyan

Daily News Analysis

Fiscal Federalism      

22nd December, 2021 Polity

Figure 1: No Copyright Infringement Intended


  • Prior to the pandemic, a series of steps by the Union government undermined the principles of federalism, especially fiscal federalism.

Steps by the Government:

  • Increasing monetary share of the States in Centrally Sponsored Schemes (CSS),
  • the terms of reference of the 15th Finance Commission,
  • imposition of demonetization without adequate consultation with the States,
  • institutionalization of the Goods and Services Tax (GST),
  • outsourcing of the statutory functions under the Smart Cities Mission,
  • a delay in transfer of GST compensation,
  • ‘One Nation One Ration’
  • The Comptroller and Auditor General found that the Union government, in 2018-19, wrongly retained ₹47,272 crore of GST compensation cess in the Consolidated Fund of India — money that was supposed to be transferred to the States. 
  • the 2021-22 Budget Estimates indicate that the States’ share of Union tax has reduced to 30% against the mandated 41% devolution prescribed by the 15th Finance Commission.
  • The establishment of the Ministry of Cooperation, as well as the Reserve Bank of India’s guidelines on cooperatives, are seen by the states as attempts to strangle a sector already reeling from the devastation of demonetisation.


Issues during the Pandemic:

  • the Union government repeatedly violated the compensation guarantees to the States under the GST regime.
  • States were curtailed in aspects relating to COVID-19 management such as procurement of testing kits, vaccination.
  • The GST compensation period expires in 2022 and the deadline has not been extended. 
  • Funding to the Chief Minister’s Disaster Relief Funds is not considered as CSR expenditure, unlike the case with PM-CARES.
  • suspension and transfer of the Member of Parliament Local Area Development (MPLAD) funds to the Consolidated Fund of India.


  • Enlarging the non-divisible pool of taxes in the form of cess in petrol tax and instituting the Agriculture Infrastructure and Development Cess have resulted in a situation where the Union continues to exclusively benefit from tax collection
  • the share of non-divisible pool cess and surcharge in total taxes collected by the Union government jumped from 12.67% in 2019-20 to 23.46% in 2020-21.
  • It led to demands for increasing borrowing limits under the Fiscal Responsibility and Budget Management Act (FRBM), from 3% to 5%. 


Way Forward:

  • as recommended by the National Commission to Review the Working of the Constitution, there should be a formal institutional framework to mandate and facilitate consultation between the Union and the States in the areas of legislation under the Concurrent List.
  • Deploy human resources to support states in preparing responses to the consultations initiated by the Union, especially with a focus on the federalism angle.
  • Chief Ministers should try to create forums for regular engagement on federalismIt would be crucial in the advocacy of major demands like the extension of GST compensation to 2027 and inclusion of cess in the divisible pool of taxes. 
  • It is critical that the Union establishes a system where citizens and States are treated as partners and not subjects.
  • Central Government legislation relating to states should include additional provisions for cost-sharing to assist them in carrying out their responsibilities.
  • In a cooperative federalist framework, it is critical to have provisions for further devolution to state governments in order to economically empower them to fulfil the aims of the New India-2022 national development programme.

About Fiscal Federalism:

  • Fiscal Federalism refers to the division of responsibilities with regards to public expenditure and taxation between the different levels of the government.
  • Fiscal federalism is the economic counterpart to political federalism.
  • It assigns functions to different levels of government and also offers appropriate fiscal instruments for carrying out these functions.
  • Determination of these specific fiscal instruments is a challenging task.


Need for better Fiscal 

  • To Check Horizontal imbalances: The horizontal imbalances arise because of differing levels of attainment by the states due to differential growth rates and their developmental status in terms of the state of social or infrastructure capital.
  • To Check Vertical imbalance: Vertical imbalance arises due to the fiscal asymmetry in powers of taxation vested with the different levels of government in relation to their expenditure responsibilities prescribed by the constitution. 
  • There is huge economic and cultural diversity among the various States. It is a terrible mistake to presume that all of India can be governed from Delhi.
  • Elected State governments and leaders cannot be made dummies without any fiscal powers for long. This fiscal federalism tension between the Centre and States can erupt into something more dangerous and spread wide.