15 Centre State Relationships: An Economic Perspective
Manjit Singh
Learning Outcome
After reading this lesson, you should be able:
To understand the relationships between the union and the states with special focus on economic relationship.
To understand and comprehend the division of resources between the Centre and the States
2. Introduction-:
Centre-State relations defines the relationships between Centre and it’s units where there exist a federal structure. In a system of federal government well established and clear cut centre-state relationship is utmost important for the proper functioning of the entire system. There is a great need of such smooth relationships in a democracy like India due to constraints posed by regionalism, plurality of religions, unbalanced growth, demand for self- government, differential political interests ,caste and race. The distribution of powers is the basis of relationship between the centre and the states in a federal structure. Part XI of the Indian constitution deals with the
provisions relating to the power distribution between the federal government (the Centre) and the States in India. These relationships are classified into legislative, administrative and financial relations.
(i) Legislative Relations (Articles 245 to 255) -: The distribution of legislative powers in the constitution of India has been done in such a way that the strong position of the centre has been maintained while simultaneously dealing with the diversity among the states. Thus in order to ensure proper distribution of legislative powers the constitutuion has called for a three tier distribution of these powers. The various legislative powers has been classified into three lists, namely , the Union List, State List and the Concurrent List. The Union List comprises of the most important areas o the administration such as Defence, Atomic Energy, Railways, Income Tax, etc. Only the Parliament has the powers to frame laws on the subjects included in the Union List. The State List comprises of the subjects that are of importance to a particular state and can be decentralized among the states. The State List includes subjects such as law and order, police, local government, public healthcare, etc. Only the State Legislature has the powers to frame laws for the subjects mentioned under the state list. The Concurrent List comprises of the subjects that are of importance to both the centre and the states. These are subjects of mutual relevance such as criminal law and procedure, stamp duties and so on. In such a case both the Parliament and the State Legislatures have the authority to frame the law. However if a situation of conflict arises between the Union Law and the State Law then the Union Law will prevail. The residual powers are vested in the Parliament
(ii) Administrative Relations (Articles 256 to 263) –: Part XI, Chapter II of the Constitution, contains the provisions related to the administrative relations between the Union and States. The constitution of India provides for a two tier governmental set up, one at the centre and the other in the states. The government at the centre is called the Union or the Central Government while the one at the state level is called the State Government. The State Government’s administrative powers are only limited to the subjects enumerated in the state list and also to some subjects in the concurrent list on which there exists no central law. The Central Government has the right to exercise its administrative powers on the matters included in the Union List and on some matters in the concurrent list where the union law exists. The Union Government also exercises these powers on the residuary subjects. In case of subjects in the concurrent lists both the central and the state government have the right to exercise their administrative power.
(iii)Financial Relations (Articles 268 to 293)-: The best system of federal finance would be one which marks a clear-cut division of sources of the revenue between the central and the State Governments so as to ensure financial independence of each other . To achieve this object, the constitution of India has detailed out provisions that deal with the distribution of the income between the centre and the states. The Indian Constitution also lays down detailed provisions regarding the borrowing power of the centre and the states and the matters relating to the grants-in-aid to the needy states by the central government. There has been a detailed explanation of the pattern of allocation of the funds between the centre and the states.
The primary objective of this chapter is to delve into the centre-state relationship from an economic view point. Therefore we will focus more on the financial relationships between the centre and state.
3. Finance Commission
Article 280 of Indian constitution provides for constitution of a Finance Commission which lays down the provisions and terms and conditions for regulating the economic and financial relationship among the two tiers of the federal government, i.e, the centre and the state. The detailed provisions regarding the establishment of the finance commission has been laid down in The Finance Commission Act of 1951. The Act contains detailed information and procedures regarding the setting up of the finance commission, the appointment of the finance commission, the qualification and disqualification of the members of the finance commission and also the varied powers entrusted to the finance commission. The Finance Commission is appointed for a period of five years by the President of India to deal with the issue of division of finances between the central and the state governments. The first such report was submitted by the commission in 1952. It lays down the principles that should be adopted to distribute the available financial resources among the states. It also deals with the question of grants-in-aid to be given to the states.
Importance/ Role of Finance Commission
Finance Commission plays the much needed role in distributing the financial resources among the centre and the state. It contributes in establishing clear cut and cordial relations between the centre and the state governments by bringing in the much required transparency and objectivity in the distribution of resources. The Finance Commission makes recommendations to the President on various issues —
The division of financial resources among the centre and the states. Such recommendations aim at ensuring objectivity and transparency in the distribution of the revenues collected by the government.
The various situations, policies, procedures, rules and regulations that deal with the approval and transfer of grants in aid to the states by the central government. Such grants in aid are given out of the Consolidated Fund of India.
The State Finance Commission provides advice and guidance to the states to help them augment the Consolidated Fund of the concerned state. Such measures include recommendations on increasing or improving the financial resources of the municipal corporations and panchayats as well.
The Finance Commission also guides the government in areas such as disinvestment from public enterprises including the timing, the mode and the extent of such disinvestment.
In certain situations the commission may provide recommendations and advice as to the price determination of the utilities such as water and electricity. .
The finance commission aims at ensuring the long term fiscal sustainability. It takes various steps aimed at enriching and improvising upon the fiscal budget through the Fiscal Responsibility Management Act.
The Finance Commission recommends various guidelines and steps to the debt ridden and poor states in an attempt to augment their financial resources and increasing their revenues.
In certain cases the President may ask for the suggestions and opinion of the finance commission on certain policy matters. However such suggestions or advice are not mandatory to be considered by the government.
A brief Overview of the Finance Commissions Appointed From the Period 1952-2015.
1951 – The first finance commission was appointed in the year 1951 for the period ranging from
1952 to 1957. The chairman of the firs finance commission was Mr. K.C. Neogy.
1956 – The second finance commission was appointed in the year 1956 for the period ranging from 1957-1962. The chairman of the second finance commission was Mr. K. Santhanam.
1960 – The third finance commission was appointed in the year 1960 for the period ranging from
1962-1966. The chairman of the third finance commission was Mr. A.K. Chanda.
1964 – The fourth finance commission was appointed in the year 1964 for the period ranging from 1966-1969. The chairman of the third finance commission was Mr. P.V. Rajamannar.
1968 – The fifth finance commission was appointed in the year 1968 for the period ranging from
1969-1974. The chairman of the fifth finance commission was Mr. Mahaveer Tyagi.
1972 – The sixth finance commission was appointed in the year 1972 for the period ranging from
1974-1979. The chairman of the sixth finance commission was Mr. K. Brahmananda Reddy.
1977 – The seventh finance commission was appointed in the year 1977 for the period ranging from 1979-1984. The chairman of the seventh finance commission was Mr. J.M. Shelath.
1983 – The eighth finance commission was appointed in the year 1983 for the period ranging from 1984-1989. The chairman of the eighth finance commission was Mr. Y.B. Chavan.
1987 – The ninth finance commission was appointed in the year 1987 for the period ranging from
1989-1995. The chairman of the ninth finance commission was Mr. N.K.P Salve.
1992 – The tenth finance commission was appointed in the year 1992 for the period ranging from
1995-2000. The chairman of the tenth finance commission was Mr. K.C. Pant.
1998 – The eleventh finance commission was appointed in the year 1998 for the period ranging
2000-2005. The chairman of the eleventh finance commission was Mr. A.M. Khusro
2002 – The twelfth finance commission was appointed in the year 2002 for the period ranging from 2005-2010. The chairman of the twelfth finance commission was Mr. C. Rangarajan.
2007 – The thirteenth finance commission was appointed in the year 2007 for the period ranging from 2010-2015. The chairman of the thirteenth finance commission was Dr. Vijay L. Kelkar.
2013 – The fourteenth finance commission was appointed in the year 2013 for the period ranging from 2015-2020. The chairman of the fourteenth finance commission was Dr. Y.V. Reddy.
4. Allocation of Taxing Powers Between the Centre and the States
The constitution of India has laid down various provisions to create an environment of stability and harmony as to the working of the government. In order to ensure smooth functioning of the government the sources of revenue have been divided among the centre and the states. The Constitution has provided various provisions as to the allocation of taxation powers between the centre and the states.
As regards to the subjects in the union list only the parliament has exclusive power to levy taxes.
As regards to the subjects in the state list only the state legislature has the exclusive power to levy taxes.
As regards to the subjects in the concurrent list both the power to levy taxes lies in the hands of the parliament and the state legislatures.
As regards to the residuary subjects which are not enumerated in any of the list only the parliament has the exclusive power to levy taxes.
5. Distribution of Tax Revenues
The 80th Amendment Act of 2000 and 88th Amendment Act of 2003 have introduced some of the important changes in the arrangement of the division of tax revenues among the centre and the state governments.
Ø The recommendations of the 10th Finance Commission were given effect with the enforcement of the 80thAmendment Act of 2000. The major recommendation of 10th Finance Commission was that the centre should give away 29% of the total income obtained from all the sources. The enforcement of this provision was done with a retrospective effect from April 1, 1996 and is known as the ‘Alternative Scheme of Devolution’. Due to this scheme the various central taxes such as custom duties and corporation tax have come at par to the level of sharing of the Income Tax among the centre and the states.
Ø Article 268-A that deals with the service tax was added after the enforcement of The 88th Amendment Act of 2003. The service tax is a tax that is imposed by the centre but it is collected and appropriated not only by the centre but also by the state. An additional subject was also added by entry 92-C that dealt with taxes on services.
The Finance Commission is set up every five years by the President of India according to the provisions of Article 280 of the Indian constitution. The aim of setting up a finance commission is to ensure proper and judicious division of financial resources between the centre and the states so that smooth functioning of the federal system can take place.
The current position of tax distribution in India is described in the following section:
(i) Taxes Levied by the Centre and collected and retained by the Centre:
There are certain taxes that are levied by the centre and are also collected and retained by the same. The centre has exclusive right over the proceeds of such taxes. No portion out of these proceeds is distributed among the states and the centre has entire control over it. Some of the taxes that fall under this category are as follows:
(i) Taxes levied on the corporations, i.e, the corporation tax (corporate tax)
(ii) Custom duties that is levied by the centre.
(iii)Surcharge that is charge upon the basic income tax.
(iv) It also includes the tax that is levied on the value of the assets of the individual and the companies.
(ii) Taxes that are levied by the Centre but Collected and Appropriated by the States (Article 268):
These taxes that are levied by the centre are charged on the subjects that are included in the union list. These taxes are collected by the states within which such duties are levied. In case of a union territory this tax is collected by the centre itself and appropriated to the concerned union territory. Some of the taxes that are included in this category are as follows:
(i) The stamp duties that are levied on insurance policies, bills of exchange , transfer of shares etc. are levied by the centre but are collected by the concerned state.
(ii) The duties such as excise duty and custom duty on some medicinal products that have alcohol or narcotics as ingredients are levied by the centre but are collected by the states.
The tax proceeds received under this category are not merged with the consolidated fund of India but are appropriated to the concerned state from where the proceeds have been generated.
(iii)Taxes Levied and Collected by the Centre but Assigned to the States (Article 269):
There are certain type of taxes that are levied and collected by the centre but these taxes are assigned to the states as per the regulatory provisions laid down in the parliament. Some of the taxes and duties that fall in this category are as follows:
(i) The taxes or duties that are levied at the time of succession of family property (other than agricultural land) is levied and collected by the centre but are then assigned to the state.
(ii) Estate duty that is imposed on property excluding the agricultural land is levied down and collected by the centre but is finally assigned to the state.
(iii)Terminal taxes that is imposed on goods and passengers that are transported by any of the modes of transportation are levied and collected by the centre but are assigned to the state
(iv) Certain taxes (excluding stamp duties) that are imposed on transactions happening in the share markets are levied and collected by the centre but assigned to the state.
(v) Certain taxes that are imposed on the revenues generated on the sale of newspapers is levied and collected buy the centre but are appropriated by the state.
(vi) Certain taxes that are imposed on the inter-state trade of goods and services is levied and collected by the centre but are assigned to the state.
(iv)Taxes Levied and Collected by the Centre and Compulsorily Distributed between the
Centre and the States:
Article 270 of the Indian constitution holds the compulsory sharing of the income tax between the centre and the states. Certain taxes such as income tax (other than agricultural income and corporation tax) that are levied by the centre and collected by the same are to be divided among the centre and the states in the manner laid down by the President of India.
(v) Taxes Levied and Collected by the Centre and may be distributed between the Centre and the States:
Unlike the income tax (which is to be compulsorily distributed), there are certain duties that may or may not be distributed among the centre and the states. This includes excise duties in the union list. These duties are levied and collected by the centre. However the net receipts of these duties will be distributed among the centre and the states only if there are provisions for the same in the parliament. The sharing of proceeds of excise duties in the union list is optional and is guided by the provisions in the Parliament.
(vi)Taxes Levied and Collected and Retained by States:
There are certain taxes and duties that is levied, collected and retained by the states. These are the subjects that are included in the state list. Some of the taxes and duties that are levied, collected and retained by the states are-:
(i) Duty charged on the succession of agricultural land is levied, collected and retained by the state itself.
(ii) Estate duty that is imposed on agricultural land levied, collected and retained by the state itself.
(iii)Taxes imposed on agricultural income are levied, collected and retained by the state itself.
(iv) Taxes imposed on land and buildings are levied, collected and retained by the state itself.
(v) Taxes imposed on the sale of electricity is levied, collected and retained by the state itself.
(vi) Taxes imposed on vehicles is levied, collected and retained by the state itself.
(vii) Sales tax imposed on the sale of goods and services is levied, collected and retained by the state itself.
(viii) Toll taxes are levied, collected and retained by the state itself.
6. Distribution of Non Tax Revenues
Apart from the tax revenues, there are some additional sources of income for both the central and the state governments. As regards to central government the receipts from postal and telegraph, public sector enterprises controlled by central government, the Indian railways, the broadcasting and banking industry, etc. are some of the important non-tax revenue for the central government. In case of the state government revenues from sectors such as fisheries, irrigation, public sector enterprises un0der the state government, forests etc. are the major sources for non-tax revenue.
- Grants-in-Aid to the States
There are certain provisions in the constitution that provide for unilateral transfers from the central government to the poor and needy states. These unilateral transfers in case of a financial need of the state are known as grants-in-aid to the states. In addition to the sharing of tax revenue between the centre and the states, the constitution provides for grants-in-aid to the states from the centre’s pool of revenue. The grants-in-aid provided by the centre to the states can be classified into three categories, viz., statutory grants discretionary grants and other grants.
A. Statutory Grants: There are certain grants that are statutory in nature. The provisions for transfer of these grants have been given in detail under article 275 of the Indian constitution. The constitution authorizes the Parliament of the country to make certain compulsory grants to the states which are financially distressed and need special financial instance. These grants are need based and are not given to every state. The amount of these grants may differ for different states as it is based on the financial need of a particular state. Additionally there may be some grants that are specifically aimed at some specific activities to be carried out by the state. The recommendations of the Finance Commission serve as the guideline for the allotment of these statutory grants to the state governments by the centre.
B. Discretionary Grants: In addition to the statutory grants mentioned under article 275 of the Indian constitution there are some discretionary grants as
well. These discretionary grants have been discussed under Article 282 of the Indian constitution. The provisions of article 282 provide that both the central government and state government may allocate grants for useful public purpose even if such an activity is not within their prescribed legislative area. The Planning Commission gives recommendations to the centre on the allocation of these discretionary grants. These grants are Discretionary in nature as there is no compulsion on the part of the central government and it is completely upon its discretion. These grants have the twin fold objectives: (i) To augment the state financially so as to meet the plan expenditures and (ii) to give influencing powers to the centre so as to ensure a a consensus between the state developmental plan and the national plan. The share of the discretionary grants is much larger as compared to the share of the statutory grants.
C. Other Grants: The constitution of India also had provisions for some other grants that were on a temporary basis. The tenure of these grants was decided to be ten years from the date of commencement of the constitution. The provision was made for some grants as a substitute for export duties on jute and jute products to some states. These grants were to be given out of the consolidated fund of India and only on the recommendations of the Finance Commission.
8. Borrowing Powers of the Government of India
The central government’s borrowing power is limited. It is limited to the extent of collateral of the revenues of the country both within the country and outside of the country. The Borrowing powers of the central government are fixed by the government from time to time. There are certain limitations upon the borrowing power of the central government that are mentioned in the constitution of the country. Such restrictions or limitations have been placed to ensure the fiscal sustainability of the governmental set up. These limitations are as follows
(i) The funds can be borrowed only within India and not from outside the country.
(ii) The State government can borrow only within the country and that too subject to following conditions. :
- (a) The borrowing process will be guided by the provisions of the constitution.
- (b) In case of an outstanding loan given by the union government to the state government, prior consent of the union government is required to raise fresh loans.