Financial federalism tells us how federal, state, and local governments share funding and administrative responsibilities within our federal system.
Since India has had a background of centralization of fiscal powers. Therefore, laws were made from time to time to improve it.
If we talk about the Government of India Act, 1935, then it is more federal than the constitution adopted on 26 January 1950, because the earlier gave more power to their provincial governments. In his last speech in the Constituent Assembly in the year 1949 , Dr. B.R. Ambedkar said that in politics we will have equality while in social and economic life we will have inequality.
Thus there was greater need for a balance of power between the central and state governments. 1950s India was never really federal. Since it was a ‘simultaneous federalism’ as opposed to ‘come together federalism’, in which small independent institutions come together to form a federation (as in the United States). Along with his effort, inequalities can be removed. He realized that there is a need for some degree of centralization in fiscal power to address the concerns of socio-economic and regional inequalities. Rajamannar Committee constituted in the year 1969 center- A committee for state financial relations, it recommended greater transfer and taxation powers for regional governments.
The Planning Commission and the Financial Commission have been the two pillars of fiscal devolution, but after 2014, the Finance Commission is the sole authority to safeguard the interests of the states.
However, there are allegations of politicization of the Finance Commission that the Finance Commission has become a political institution tilted towards the central government and with arbitrary and implicit bias.
This is the reason why the financial capabilities of the state have also declined. There has been a decline in the self earned revenue of the states. The ability of states to finance current expenditure from their own revenue has declined from 69% in 1955-56 to less than 38% in 2019-20. The expenditure of the states is increasing but their revenue has not increased. Since states cannot increase tax revenue due to cuts in indirect tax rights – excluding petroleum products, electricity and liquor – the GST includes –
Revenue has remained stagnant at 6% of GDP over the past decade.
Apart from this, some recent examples that hinder fiscal federalism in India are as follows-
If we talk about GST, because of GST, the states have lost the autonomy to decide the tax rates of the subjects in the state list. The inability of states to fix tax rates to meet their development needs means greater dependence on the Center for funds. The same non-divisive cess and surcharge are also not rational. Even the increased share of devolution, proposed by the Fourteenth Finance Commission, from 32% to 42%, was removed by raising the non-divisive cess and surcharge that goes directly to the union kitty. The apportionment pool increased from 9.43% in 2012 to 15.7% in 2020, shrinking the divisible pool of resources for devolution to states.
Corporate tax has also come down.
Instead of strengthening direct taxation, the central government reduced corporate tax from 35% to 25% in 2019 and monetized its public sector assets to finance infrastructure. The issue of differential interest also affects financial federalism. States are forced to pay different interest rates for market borrowings – around 10% as against 7% – by the Union. The Center continues to set market borrowing limits for states under Article 293 of the Constitution Is. It is against their autonomy.
The development work has also been hampered due to the suspension of MPLAD. The central government suspended the MPLAD scheme and diverted that money to the Consolidated Fund of India, leading to centralization of the country’s financial resources. The issue of centrally sponsored schemes is also a subject of significant controversy for fiscal federalism. There are 131 centrally sponsored schemes, of which a few dozen account for 90% of the allocation, and states are required to share a portion of the cost.
They spend about 25% to 40% in the form of similar grants at the expense of their priorities. These plans, driven by a one-size-fits-all approach, are given priority over state plans.