Centralisation of Fiscal Powers and Declining Fiscal Capacity of States

2022 AUG 17

Mains   > Economic Development   >   Indian Economy and issues   >   Centre-State Finance


  • The ongoing process of centralisation of fiscal powers has resulted in the declining fiscal capacity of states.


  • A degree of centralisation in fiscal power was required to address the concerns of socio-economic and regional disparities that existed when India became a republic in 1950.
  • Thus, our national leaders and constitutional makers supported an asymmetric federalism with a degree of fiscal centralization, which is reflected in our Constitution.
  • Historically, India’s fiscal transfer worked through two pillars, i.e., the Planning Commission and the Finance Commission. But the waning of planning since the 1990s, and its abolition in 2014, led to the Finance Commission becoming a major means of fiscal transfer as the commission itself broadened its scope of sharing all taxes since 2000 from its original design of just two taxes — income tax and Union excise duties.
  • Today, the Finance Commission is criticised as a politicised institution with inherent bias towards the Union government.
  • The asymmetric federalism, inherent to the Constitution, has accelerated and mutually reinforced with political centralization since 2014, severely impacting the fiscal capacity of states.


  • Implementation of GST and decline in revenue:
    • The ability of the States to expand revenue has been constrained since the Goods and Services Tax (GST) regime was adopted.
    • Also, the GST compensation (GSTC) has come to an end on June 30, 2022, and it will severely affect the fiscal capacity of states.
  • Increase in non-divisive cess and surcharges:
    • The increased share of devolution, mooted by the Fourteenth Finance Commission, from 32% to 42%, was subverted by raising non-divisive cess and surcharges that go directly into the Union kitty.
    • This non-divisive pool in the Centre’s gross tax revenues shot up to 15.7% in 2020 from 9.43% in 2012, shrinking the divisible pool of resources for transfers to States.
  • Issue of differential interest:
    • States are forced to pay differential interest about 10% against 7% by the Union for market borrowings.
  • Centrally sponsored schemes curb the autonomy of states:
    • By turning States into mere implementing agencies of the Union’s schemes, their autonomy has been curbed.
    • There are 131 centrally sponsored schemes, with a few dozen of them accounting for 90% of the allocation, and States required to share a part of the cost. They spend about 25% to 40% as matching grants at the expense of their priorities.
    • The diversion of a state’s own funds to centrally sponsored schemes results in depleting resources for its (state’s) own schemes.
    • Also a centrally sponsored scheme on an item that is in the State list and State sharing the expenditure of a scheme on the Union list is against the spirit of federalism, specifically fiscal federalism.


  • Cess and surcharges must be shared with the states to improve the financial capacity of states as the ability of States to finance current expenditures from their own revenues has declined from 69% in 1955-56 to less than 38% in 2019-20.
    • While the expenditure of the States has been shooting up, their revenues did not.
    • They still spend 60% of the expenditure in the country85% in education and 82% in health.
  • Centre should try to increase the divisible pool in tax revenue by various measures including widening the tax base, preventing tax evasion etc.
  • The non-divisive surcharges and cesses used by the centre should not hurt the divisive pool of tax revenue.
  • Both the centre and the states should follow the spirit of cooperative federalism, and should constructively solve the issues, including GST compensation, through proper discussions.
  • Necessary reforms in GST council should be taken to promote fiscal decentralization and cooperative federalism.


  • It is the state that mostly implements welfare schemes and provides basic necessities to the citizens. Therefore, the states play a significant role in improving the lives of citizens, for which the states require fiscal autonomy.


Q. “The systematic weakening of States serves neither federalism nor national interest”. Discuss the statement with reference to declining fiscal capacity of the states in India.