Fiscal federalism can best be understood as the economic counterpart to political federalism. It has to do with delegating functions to various levels of government and providing adequate financial resources to carry them out.
Revenue distribution is particularly important in determining the character of the state's relationship with the Centre. Taxation powers are incorporated in the union list and the state list of the Constitution; both lists are exhaustive and mutually exclusive. Articles 268 to 293 deal with the provisions governing the Centre's financial ties with the States.
Distribution Of Tax Analysis
A cursory examination of the distribution of taxation authorities in the union list and state list reveals that the majority of the elastic sources of revenue have been reserved for the Centre. The Centre has relatively expensive revenue streams, whereas state governments are burdened with relatively expensive functions that are not fully compensated by their revenue sources.
Dominant centre: restraints the state
In light of the regional imbalances caused by topography, demography and geography, all resources generated by the state cannot be retained wholly within the state, as this would exacerbate the imbalances, which would be detrimental to political and fiscal stability.
Additionally, the Sarkaria commission justified increased fiscal powers for the union on the grounds that the power to tax can be used not only to raise revenue but also to regulate economic activity, and that devolving that power to states may jeopardise national interests by encouraging states to pursue regional agendas that may conflict with national interests. Parochialism is a reality. State leaders have the tendency to pursue populist regional agendas at the cost of national interest which is not desirable.
State subordination at the expense of development
On the other side, states argue that they require taxation authority in order to mobilise resources to address developmental objectives, as excessive reliance on the union for resources might occasionally result in union biases and imbalances. States are at the vanguard of development and opportunity generation. Strong states inevitably result in a stronger India. State abolition serves neither federalism nor national interest.
Goods And Services Tax (GST)
The goods and services tax, or GST, is possibly the most significant fiscal reform undertaken by the government since independence. It reestablished the Centre-state connection and altered the way commerce is conducted and governments operate.
Due to the fact that the GST is a destination tax, there is a direct link between consumption and tax revenue. It provides an incentive for states by introducing the element of elasticity, which encourages states to take measures toward higher economic efficiency. The ability of a state government to independently determine its indirect tax policy is a federal power derived from the constitution. With the adoption of GST, this authority over indirect tax policy will be transferred to the newly constituted constitutional body known as the Goods and Services Tax Council (GST Council).
The council is composed of elected representatives from the union and state governments. To be approved by the council, a proposal must receive 3/4th (75 per cent) of the total votes cast (of those present and voting). The union government has 1/3rd of the votes (33.33 per cent), whereas all 31 state governments (the elected governments of all 29 states and the union territories of Delhi and Puducherry that are members of the GST Council) have 2/3rds of the votes combined (66.67 per cent). Given that all member states have an equal number of votes, each state has (about) 2.15 per cent of the total votes.
There is a clear disparity between the union and state governments in terms of vote share. The union has the right to veto any proposal made by the states, even if all 31 states hypothetically agree. On the other hand, the union government requires the concurrence of no more than twenty states in addition to its own to make a decision. Given that the national political party/coalition in power at the centre is generally expected to hold significant power in a number of states, the voices of states led by regional parties (which are not allies of the national political party/coalition in power at the centre) may be ignored during the council's decision-making process.
As a result of this disparity in vote share, elected state governments stand to lose significant federal authority over indirect taxation. Alternatively, some have argued that GST, rather than impinging on Indian federalism, will foster the ethos of 'cooperative federalism'—that states and the union will 'cooperate' for a greater good. The incumbent union believes that the GST Council demands states and the union to engage in constructive discourse, collaborate, and reach a mutual agreement, hence fostering a cooperative atmosphere.
State governments power to borrow is limited
they cannot borrow from outside the country
In the domestic market they have limitations:
In case they have borrowed from the Union government and the loan remains outstanding they can’t borrow from the market without the permission of the union government.
In case they have borrowed from the market in such case the counter guarantees given by the union they cannot get fresh loans without the approval of the union government.
Centrally Sponsored Scheme:
Grants meant for centrally sponsored schemes required states to make matching contributions and do not give them the autonomy to design or implement the schemes. Additionally, they are one-size-fits-all plans, as they are not adapted to each state's unique ground-level requirements.
The 14th finance commission strongly urges that the Centre limit the number of centrally supported schemes and instead allocate resources to states to allow them to develop, administer, and oversee the ultimate use of money at the state and local levels.
To avoid political prejudices, both the federal government and each of the states must put aside their differences. A budgetary consolidation strategy geared toward growth and progress must be prioritised.
National interest influences and is influenced by state development, and vice versa. In order to meet the needs of the states, the Centre must be receptive to their requests, and the states, for their part, must align their policies with the spirit of team India and rise above parochialism. Cooperative federalism and fiscal consolidation is the way forward. The need is to push for balanced growth of all regions, given the diversity and distinction the centre cannot adopt one size fits all approach, there’s a need to be accommodative and receptive to concerns of states.