Revision summary
Finance Commissions devolve taxes; Planning Commission Plan grants created a discretionary second channel. Sarkaria and Punchhi criticised that discretion. NITI Aayog ended Plan cheques; 14th FC raised the States’ share of the divisible pool to 42%. GST shares tax but limits State rate power; cesses outside the pool and CSS keep Union leverage. Article 293 borrowing conditions remain a hard federal tool.
Model answer
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Introduction
Fiscal federalism in India has evolved from a centralised, plan-driven transfer system to a more rule-based framework of tax devolution and cooperative federalism. Planned development created a dual channel of transfers through the Finance Commission and Planning Commission, while recent reforms such as NITI Aayog, GST and higher tax devolution have altered the balance between State autonomy and Union coordination.
Body
Evolution during Planned Development
The planning era was characterised by a dual-channel system of Centre-State transfers.
- Finance Commission: Under Article 280, it recommended tax devolution and grants as the constitutional mechanism for sharing resources.
- Planning Commission: As a non-constitutional executive body, it provided discretionary Plan grants and determined development priorities, often giving the Centre considerable influence over State finances.
- Gadgil-Mukherjee Formula: Provided a structured basis for distributing Plan assistance, but the centrally determined framework gave States limited flexibility to address their specific developmental needs.
- Centrally Sponsored Schemes: Their rigid guidelines and matching contributions increased State dependence on Central priorities and reduced fiscal space.
Thus, planned development addressed both vertical imbalance between the Centre and States and horizontal imbalance among States, but the discretionary nature of Plan transfers strengthened centralisation.
Shift after 2014: From Centralised Planning to Cooperative Federalism
NITI Aayog, 2015: Abolition of the Planning Commission ended its role as a discretionary channel for Plan grants. NITI Aayog became a policy think tank, thereby giving greater importance to the Finance Commission as the constitutional channel of fiscal devolution.
14th Finance Commission: Increased States' share in the divisible pool from 32% to 42%, substantially expanding untied resources and State fiscal autonomy. The 15th and 16th Finance Commissions retained 41%, after accounting for the reorganisation of Jammu and Kashmir.
Impact of Recent Reforms on Fiscal Federalism
1. GST: Greater cooperation but reduced State tax autonomy
The 101st Constitutional Amendment Act, 2016 introduced GST and created the GST Council under Article 279A.
It strengthened fiscal federalism by creating a common forum for Centre-State decision-making and pooling tax sovereignty. However, States surrendered important independent taxation powers such as VAT and entry taxes. The expiry of the GST compensation mechanism in 2022 further exposed States to revenue uncertainty.
2. Greater rule-based devolution but growing conditionality
The reforms shifted the system away from discretionary Plan transfers, but fiscal transfers have increasingly become compliance-driven and performance-linked.
The 16th Finance Commission's framework links assistance with fiscal discipline, power-sector reforms, subsidy rationalisation and PSE restructuring. Local-body grants also increasingly carry performance conditions. Thus, States have gained predictable resources but face greater conditions attached to their fiscal space.
3. Cesses and surcharges: Continuing centralisation
Despite higher devolution percentages, cesses and surcharges are outside the divisible pool. Their increasing use reduces the effective pool available for sharing with States, creating a gap between the nominal devolution percentage and actual fiscal resources transferred.
4. Borrowing constraints
Under Article 293, States face restrictions on borrowing when they are indebted to the Union. Fiscal stress and deficit limits have therefore strengthened the Union's influence over State borrowing and fiscal management.
Overall Assessment
Recent reforms have produced a mixed transformation:
- More fiscal autonomy: Higher Finance Commission devolution and the end of discretionary Plan grants.
- More cooperative federalism: GST Council provides a common institutional platform for tax decisions.
- Less tax autonomy: GST brought major State indirect taxes into a common system.
- Continued Union leverage: Cesses, surcharges, Centrally Sponsored Schemes and Article 293 borrowing conditions constrain State fiscal space.
- Greater conditionality: Performance-linked and reform-linked transfers increasingly influence State spending priorities.
Hence, fiscal federalism has moved from discretionary centralised planning to rule-based but increasingly conditional devolution rather than towards complete fiscal autonomy for States.
Flow diagram
Conclusion
The trajectory of Centre-State financial relations reflects a shift from centralised planning to rule-based fiscal federalism, with NITI Aayog and higher Finance Commission devolution strengthening State autonomy. However, GST-related loss of tax autonomy, cesses and surcharges, conditional grants and borrowing restrictions continue to preserve significant Union leverage. The present model therefore represents greater cooperation without complete fiscal decentralisation.
Quick related
Students also ask
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What changes has the Union Government recently introduced in the domain of Centre-State relations? Suggest measures to be adopted to build the trust between the Centre and the States and for strengthening federalism.
Next question on this syllabus topic (2024 · Q13). View answer →
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Did NITI Aayog make States richer?
It stopped being a grant-giver. Richer or poorer now depends on the Finance Commission, GST yield and CSS, not on NITI cheques.
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Are cesses unconstitutional?
They are allowed, but heavy use of cess and surcharge undermines the spirit of tax sharing that the FC is meant to run.
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Q13 · UPSC Mains 2024 · GS II · 15 marks · Solution
What changes has the Union Government recently introduced in the domain of Centre-State relations? Suggest measures to be adopted to build the trust between the Centre and the States and for strengthening federalism.
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