{"id":369052,"date":"2026-08-06T18:01:41","date_gmt":"2026-08-06T12:31:41","guid":{"rendered":"https:\/\/forumias.com\/blog\/?p=369052"},"modified":"2026-08-07T12:16:06","modified_gmt":"2026-08-07T06:46:06","slug":"fiscal-federalism-in-india-significance-challenges-explained-pointwise","status":"publish","type":"post","link":"https:\/\/forumias.com\/blog\/fiscal-federalism-in-india-significance-challenges-explained-pointwise\/","title":{"rendered":"Fiscal Federalism in India &#8211; Significance &#038; Challenges &#8211; Explained Pointwise"},"content":{"rendered":"<p><img data-recalc-dims=\"1\" loading=\"lazy\" decoding=\"async\" class=\"aligncenter size-large wp-image-369058\" src=\"https:\/\/i0.wp.com\/forumias.com\/blog\/wp-content\/uploads\/2026\/08\/ChatGPT-Image-Aug-6-2026-06_00_02-PM.png?resize=750%2C500&#038;ssl=1\" alt=\"Fiscal federalism in India\" width=\"750\" height=\"500\" srcset=\"https:\/\/i0.wp.com\/forumias.com\/blog\/wp-content\/uploads\/2026\/08\/ChatGPT-Image-Aug-6-2026-06_00_02-PM.png?resize=1024%2C683&amp;ssl=1 1024w, https:\/\/i0.wp.com\/forumias.com\/blog\/wp-content\/uploads\/2026\/08\/ChatGPT-Image-Aug-6-2026-06_00_02-PM.png?resize=300%2C200&amp;ssl=1 300w, https:\/\/i0.wp.com\/forumias.com\/blog\/wp-content\/uploads\/2026\/08\/ChatGPT-Image-Aug-6-2026-06_00_02-PM.png?resize=768%2C512&amp;ssl=1 768w, https:\/\/i0.wp.com\/forumias.com\/blog\/wp-content\/uploads\/2026\/08\/ChatGPT-Image-Aug-6-2026-06_00_02-PM.png?w=1536&amp;ssl=1 1536w\" sizes=\"auto, (max-width: 750px) 100vw, 750px\" \/><\/p>\n<p>Fiscal federalism in India balances resource distribution between the Union and states to ensure cooperative governance. The <a href=\"https:\/\/forumias.com\/blog\/16th-finance-commission-recommendations-explained-pointwise\/\" target=\"_blank\" rel=\"noopener\">16th Finance Commission<\/a>, chaired by Dr. <span class=\"citation-3 citation-end-3\">Arvind Panagariya, retained vertical tax devolution at 41% while introducing performance-driven criteria like GDP contribution.<\/span> This framework aims to harmonize regional equity, fiscal discipline, and sub-national autonomy for 2026-31.<\/p>\n<table style=\"width: 100%; border-collapse: collapse; border-style: solid;\">\n<tbody>\n<tr>\n<td style=\"width: 100%; text-align: center;\"><strong>Table of Content<\/strong><\/td>\n<\/tr>\n<tr>\n<td style=\"width: 100%;\"><a href=\"#toc1\">What is Fiscal Federalism? What are the constitutional provisions which provide for Fiscal Federalism in India?<\/a><br \/>\n<a href=\"#toc2\">What are the Challenges to Fiscal Federalism in India?<\/a><br \/>\n<a href=\"#toc3\">What is the Significance of Fiscal Federalism?<\/a><br \/>\n<a href=\"#toc4\">What are the finance commission recommendations for Fiscal federalism?<\/a><br \/>\n<a href=\"#toc4\">What should be the way Forward to strengthen Fiscal Federalism in India?<\/a><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<h2 class=\"blue-h2-box\"><span style=\"text-decoration: underline;\"><span style=\"color: #000000; text-decoration: underline;\"><strong><a id=\"toc1\"><\/a>What is Fiscal Federalism? What are the constitutional provisions which provide for Fiscal Federalism in India?<\/strong><\/span><\/span><\/h2>\n<ul>\n<li><strong>Fiscal Federalism:<\/strong>\u00a0Fiscal federalism refers to the <span style=\"color: #ff0000;\">division of financial powers and responsibilities<\/span> between the <span style=\"color: #ff0000;\">central government<\/span> and state governments in India.<\/li>\n<li><strong>Constitutional Provisions:<\/strong> The Indian Constitution defines the taxation and expenditure powers of the central and state governments through various provisions:\n<ol style=\"list-style-type: lower-alpha;\">\n<li><strong>Seventh Schedule:<\/strong>\u00a0The Constitution <span style=\"color: #ff0000;\">assigns specific tax bases<\/span> to the central and state governments, listed in the <span style=\"color: #ff0000;\">Union List<\/span> and <span style=\"color: #ff0000;\">State List<\/span> respectively.<\/li>\n<li><strong>Article 270:<\/strong>\u00a0Article 270 of the Indian Constitution provides for the <span style=\"color: #ff0000;\">distribution of net tax proceeds<\/span> collected by the Union government between the Centre and the States.<\/li>\n<li><strong>Article 280:<\/strong>\u00a0The <span style=\"color: #ff0000;\">Finance Commission<\/span> which is a constitutional body under Article 280, recommends the <span style=\"color: #ff0000;\">sharing<\/span> of <span style=\"color: #ff0000;\">tax revenues<\/span> and <span style=\"color: #ff0000;\">grants-in-aid to the states<\/span>.<\/li>\n<li><strong>Article 275:<\/strong>\u00a0It provides for the grants-in-aid system which involves discretionary transfers from the Centre to states for specific purposes.<\/li>\n<\/ol>\n<\/li>\n<li><strong>Examples of Cooperative Fiscal Federalism:<\/strong>\n<ol>\n<li><strong>Introduction of GST:<\/strong>\u00a0The introduction of Goods and Services Tax (GST) through the 101st Constitutional Amendment is a <span style=\"color: #ff0000;\">historic example of cooperative fiscal federalism in India<\/span>. The GST act has <span style=\"color: #ff0000;\">transformed India&#8217;s indirect tax landscape<\/span>, and <span style=\"color: #ff0000;\">fostered Centre-State cooperation<\/span>.<\/li>\n<li><strong>Passage of FRBM Act:<\/strong>\u00a0The Fiscal Responsibility and Budget Management (FRBM) Act 2003 aims to promote fiscal discipline at the central and state levels. <span style=\"color: #ff0000;\">21 states enacted their own FRBM Acts<\/span>, incentivized by debt and interest rate relief provided by the 12th Finance Commission. This is a historic example of <span style=\"color: #ff0000;\">centre-state cooperation in maintenance of Fiscal prudence<\/span>.<\/li>\n<li><strong>Introduction of performance based grants:<\/strong>\u00a0Performance-based grants are being used to incentivize states to achieve developmental targets. This has led to <span style=\"color: #ff0000;\">competitive and cooperative federalism<\/span> between the Centre and States in the sphere of finances and public expenditure.<\/li>\n<\/ol>\n<\/li>\n<\/ul>\n<h2 class=\"blue-h2-box\"><span style=\"text-decoration: underline;\"><span style=\"color: #000000; text-decoration: underline;\"><strong><a id=\"toc2\"><\/a>What are the Challenges to Fiscal Federalism in India?<\/strong><\/span><\/span><\/h2>\n<ol>\n<li><strong>Vertical Fiscal Imbalance<\/strong>: States bear a disproportionate share of expenditure responsibilities (agriculture, health, education, law and order, rural development) relative to their revenue-raising powers. The Centre collects a larger share of aggregate revenue but has comparatively fewer expenditure obligations, making states dependent on transfers.<\/li>\n<li><strong>Reduced Financial Transfers to the States: <\/strong>The\u00a0<span style=\"color: #ff0000;\">share of states in the gross tax revenue<\/span>\u00a0(total tax revenue collected, which includes cess and surcharges) has\u00a0decreased\u00a0from\u00a0<span style=\"color: #ff0000;\">35% in 2015-16<\/span>\u00a0to\u00a0<span style=\"color: #ff0000;\">30% in 2023-24<\/span>.<\/li>\n<li><strong>Disproportionate Growth between Union Govt\u2019s &amp; State Govt\u2019s Revenue: <\/strong>From 2015-16 to 2023-24, while the\u00a0<span style=\"color: #ff0000;\">Union government\u2019s tax revenue<\/span>\u00a0has increased by<span style=\"color: #ff0000;\"> 2.3 times<\/span>\u00a0from \u20b914.6 lakh crore to \u20b933.6 lakh crore, the\u00a0<span style=\"color: #ff0000;\">states\u2019 share in the tax revenue<\/span> has <span style=\"color: #ff0000;\">only doubled\u00a0<\/span>from \u20b95.1 lakh crore to \u20b910.2 lakh crore. This indicates a <span style=\"color: #ff0000;\">disproportionate growth<\/span> between <span style=\"color: #ff0000;\">Union Govt\u2019s<\/span> and <span style=\"color: #ff0000;\">State Govt\u2019s Revenues<\/span>.<\/li>\n<li><strong>Decrease in Grants-in-Aid to the states:<\/strong>\u00a0Direct financial support to states, in the form of grants-in-aid, has\u00a0<span style=\"color: #ff0000;\">declined from\u00a0\u20b91.95 lakh crore in 2015-16<\/span>\u00a0to\u00a0<span style=\"color: #ff0000;\">\u20b91.65 lakh crore in 2023-24<\/span>.<\/li>\n<li><strong>Increase in the share of non-devolvable cess and surcharge:<\/strong> The increasing reliance on <strong data-start=\"778\" data-end=\"803\">cesses and surcharges<\/strong>, which are <strong data-start=\"815\" data-end=\"832\">not shareable<\/strong> with States under <strong data-start=\"851\" data-end=\"866\">Article 270<\/strong>, has reduced the effective divisible pool. The share of cesses and surcharges in the Union&#8217;s gross tax revenue has risen from <strong data-start=\"993\" data-end=\"1017\">around 10% (2011\u201312)<\/strong> to <strong data-start=\"1021\" data-end=\"1050\">about 20% in recent years<\/strong>, reducing States&#8217; share.<\/li>\n<li><strong>Centralisation of Public Expenditure:<\/strong>\u00a0<span style=\"color: #ff0000;\">Out of the\u00a0combined allocation of \u20b919.4 lakh crore<\/span>\u00a0for Centrally Sponsored Schemes (CSS) and Central Sector Schemes (CSec Schemes) in 2023-24,\u00a0<span style=\"color: #ff0000;\">only \u20b94.25 lakh crore was devolved to States<\/span>. These are\u00a0<span style=\"color: #ff0000;\">tied grants<\/span>\u00a0and <span style=\"color: #ff0000;\">the states have no autonomy to plan their expenditure<\/span>.<\/li>\n<li><strong>Interstate Inequality in public Finances through CSS schemes:<\/strong>\u00a0The Union government compels the State to commit more or less an equivalent quantum of financial resources in the implementation of CSS schemes. <span style=\"color: #ff0000;\">Wealthy States can afford to commit equivalent finances<\/span> and leverage Union finances inwards through the implementation of CSS. However, <span style=\"color: #ff0000;\">less wealthy States will have to commit their borrowed finances in these CSS<\/span>, thus <span style=\"color: #ff0000;\">increasing their own liabilities<\/span>. It has created inter-state inequality in public finances.<\/li>\n<li><strong>Increase in Conditional Transfers:<\/strong>\u00a0Several grants to states are contingent on fulfilling certain conditions, including <span style=\"color: #ff0000;\">the insistence on specific labelling,<\/span> which imposes Union government preferences over state priorities.<\/li>\n<li><strong>Erosion of State Taxation Autonomy on account of implementation of GST:<\/strong>\u00a0The <span style=\"color: #ff0000;\">ability of states to set tax rates on their own revenue sources<\/span> has been <span style=\"color: #ff0000;\">significantly diminished<\/span> due to the implementation of GST.\u00a0<strong>For ex-<\/strong> State VAT have been subsumed under GST.<\/li>\n<li><strong>Issues with GST:<\/strong> States surrendered the power to independently set rates for major indirect taxes (VAT, sales tax, entry tax) in favor of a unified GST regime. The GST Compensation Cess (guaranteeing 14% annual revenue growth to states) expired in 2022, and its extension has been used mainly to service compensation loan repayments, thus, leaving the states more exposed to GST revenue volatility.<\/li>\n<\/ol>\n<table style=\"width: 100%; border-collapse: collapse; border-style: solid;\">\n<tbody>\n<tr>\n<td style=\"width: 100%;\">Read More- <a href=\"https:\/\/forumias.com\/blog\/on-the-issues-with-fiscal-federalism\/\" target=\"_blank\" rel=\"noopener\">On the Issues with Fiscal federalism<\/a><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<h2 class=\"blue-h2-box\"><span style=\"text-decoration: underline;\"><span style=\"color: #000000; text-decoration: underline;\"><strong><a id=\"toc3\"><\/a>What is the Significance of Fiscal Federalism?<\/strong><\/span><\/span><\/h2>\n<ol>\n<li><strong>Ensures Balanced Distribution of Resources:<\/strong>\u00a0Fiscal federalism allows the central and state governments to <span style=\"color: #ff0000;\">address<\/span> the <span style=\"color: #ff0000;\">regional imbalances<\/span> through mechanisms like <span style=\"color: #ff0000;\">tax sharing<\/span>, <span style=\"color: #ff0000;\">grants-in-aid<\/span>, and <span style=\"color: #ff0000;\">performance-based incentives<\/span>. Thus, it enables states with lower revenue capacity to still deliver comparable public services through equalizing transfers.<\/li>\n<li><strong>Strengthens Cooperative Federalism:<\/strong>\u00a0Fiscal federalism encourages cooperation and coordination between the Centre and states, as they negotiate the sharing of resources and responsibilities. <strong>For e.g.<\/strong>\u00a0The <span style=\"color: #ff0000;\">GST Council brings together the Centre and states<\/span> to jointly administer the Goods and Services Tax.<\/li>\n<li><strong>Promotes Equitable Regional Development<\/strong>: Devolution formulas (income distance, area, population, forest cover, demographic performance) aim to channel more resources to less-developed states, helping bridge regional disparities. Special provisions for hill states, North-East, and island territories address geographic and historical disadvantages.<\/li>\n<li><strong>Ensuring Fiscal Discipline:<\/strong>\u00a0Fiscal federalism frameworks like the <span style=\"color: #ff0000;\">Fiscal Responsibility and Budget Management<\/span> (<span style=\"color: #ff0000;\">FRBM<\/span>) <span style=\"color: #ff0000;\">Act<\/span> promote fiscal discipline at both the central and state levels. This helps <span style=\"color: #ff0000;\">maintain macroeconomic stability and sustainability<\/span>.<\/li>\n<li><strong>Enabling Decentralized Governance:<\/strong>\u00a0Fiscal federalism <span style=\"color: #ff0000;\">supports decentralization<\/span> by empowering state and local governments with financial autonomy and resources. This <span style=\"color: #ff0000;\">strengthens grassroots democracy<\/span> and <span style=\"color: #ff0000;\">responsive governance<\/span> closer to the people. Local bodies with adequate finances can respond faster to local needs (sanitation, primary education, local infrastructure) than a distant central authority.<\/li>\n<li><strong>Undertaking Economic Reforms:<\/strong>\u00a0Fiscal federalism helps to adapt to changes like the shift towards a market-oriented economy (<span style=\"color: #ff0000;\">1991 economic reforms<\/span>), and undertake taxation reforms like <span style=\"color: #ff0000;\">the introduction of GST<\/span>.<\/li>\n<\/ol>\n<h2 class=\"blue-h2-box\"><span style=\"text-decoration: underline;\"><span style=\"color: #000000; text-decoration: underline;\"><strong><a id=\"toc5\"><\/a>What are the finance commission recommendations for Fiscal federalism?<\/strong><\/span><\/span><\/h2>\n<p>The Finance Commissions have made several important recommendations over the years to promote fiscal federalism in India:<\/p>\n<ol>\n<li><strong>Vertical Tax Devolution:<\/strong>\u00a0The 14th Finance Commission radically increased the share of states in the central divisible pool of taxes from 32% to 42%,<span style=\"color: #ff0000;\"> the biggest ever increase in vertical tax devolution<\/span>. This enhances the fiscal autonomy and resources of state governments. The 15th Finance Commission reduced it to 41% &amp; the 16th Finance Commission retained it at 41%.<\/li>\n<li><strong>Horizontal Distribution Formula:<\/strong> The 16th FC recommended distribution among States based on the following criteria: <strong data-start=\"862\" data-end=\"889\">Income Distance (42.5%)<\/strong>, <strong data-start=\"891\" data-end=\"918\">Population 2011 (17.5%)<\/strong>, <strong data-start=\"920\" data-end=\"953\">Demographic Performance (10%)<\/strong>, <strong data-start=\"955\" data-end=\"969\">Area (10%)<\/strong>, <strong data-start=\"971\" data-end=\"997\">Forest &amp; Ecology (10%)<\/strong>, and <strong data-start=\"1003\" data-end=\"1033\">Contribution to GSDP (10%)<\/strong>, balancing equity with incentives for economic performance.<\/li>\n<li><strong>Grants-in-Aid:<\/strong>\u00a0The Finance Commissions <span style=\"color: #ff0000;\">provide grants-in-aid to specific states or sectors<\/span> that are in need of assistance or reform. This promotes the spirit of competitive and cooperative fiscal federalism.<\/li>\n<li><strong>Fiscal Consolidation: <\/strong>The finance commissions have suggested maintenance of fiscal prudence by the states. The <span style=\"color: #ff0000;\">12th FC recommended a multi-dimensional restructuring<\/span> aimed at both qualitative and quantitative aspects of managing government finances. The 16th FC recommended a medium-term fiscal path targeting <strong data-start=\"1459\" data-end=\"1498\">Union fiscal deficit of 3.5% of GDP<\/strong> and <strong data-start=\"1503\" data-end=\"1541\">State fiscal deficit of 3% of GSDP<\/strong> by <strong data-start=\"1545\" data-end=\"1556\">2030\u201331<\/strong>, ensuring debt sustainability.<\/li>\n<li><strong>Strengthening State Finance Commissions (SFCs)<\/strong>: Various FC over the years recommended closer integration of Central Finance Commission transfers with timely SFC recommendations and suggested constitutional changes to improve the functioning of SFCs.<\/li>\n<\/ol>\n<h2 class=\"blue-h2-box\"><span style=\"text-decoration: underline;\"><span style=\"color: #000000; text-decoration: underline;\"><strong><a id=\"toc4\"><\/a>What should be the way Forward to strengthen Fiscal Federalism in India?<\/strong><\/span><\/span><\/h2>\n<ol>\n<li><strong>Reform Horizontal Devolution Criteria<\/strong>: Move toward a <strong>more balanced formula<\/strong> that doesn&#8217;t penalize demographic and developmental success for e.g. using a rolling\/updated population base rather than freezing it at 1971 or 2011, or giving greater weight to &#8220;demographic performance&#8221; alongside &#8220;need-based&#8221; criteria.<\/li>\n<li><strong>Rationalisation of Public Expenditure by Central Govt:<\/strong>\u00a0A mechanism must be instituted for thorough <span style=\"color: #ff0000;\">financial rationalisation of the Central Sector and Centrally Sponsored schemes<\/span>, in collaboration with state governments. Centrally Sponsored Schemes should be consolidated and pruned to cover only core national priorities (e.g. primary health, basic education, rural employment).<\/li>\n<li><strong>Addressing the GST related Concerns:<\/strong>\u00a0The <span style=\"color: #ff0000;\">anomalies in GST like the Integrated GST<\/span> which favours the consuming states like UP and Bihar, rather than the producing states of TN, Gujarat <span style=\"color: #ff0000;\">must be corrected<\/span>. Also, efforts must be undertaken to <span style=\"color: #ff0000;\">open more avenues for revenue generation<\/span> by broadening the scope of GST to include petrol, diesel etc.<\/li>\n<li><strong>Revisiting Article 246 and the Seventh Schedule:<\/strong>\u00a0The <span style=\"color: #ff0000;\">taxation powers listed in the seventh schedule<\/span> must be relooked in the context of fiscal federalism.<\/li>\n<li><strong>List of Taxation for Third Tier of Govt:<\/strong>\u00a0Specific taxation powers <span style=\"color: #ff0000;\">must be devolved to the local self governments<\/span> to help them raise their own resources and <span style=\"color: #ff0000;\">reduce their dependence on grant-in-aids<\/span>. This will help in achieving fiscal federalism in its true sense.<\/li>\n<li><strong>Reduction of Borrowing Constraints on States:<\/strong> The Union government should revisit the borrowing constraints placed on state investment funds, as suggested by Kerala.<\/li>\n<li><strong>Address the Issue of Cesses and Surcharges:<\/strong> Bring cesses and surcharges into the divisible pool, or at minimum cap their share of gross tax revenue, since their rising share bypasses the Finance Commission&#8217;s constitutional mandate (Article 270).<\/li>\n<li><strong>Minimisation of the discretionary aspect of transfers to states:<\/strong>\u00a0Some of these transfers can be made automatic. For other transfers, clear and non-discriminatory methods should be followed.<\/li>\n<li><b data-path-to-node=\"15,0,0\" data-index-in-node=\"0\">Mandatory State Finance Commission (SFC) Implementation:<\/b> Mandate that state governments accept and implement SFC recommendations within a strict statutory timeframe, or tie a portion of central transfers to SFC compliance.<\/li>\n<\/ol>\n<table style=\"width: 100%; border-collapse: collapse; border-style: solid;\">\n<tbody>\n<tr>\n<td style=\"width: 100%;\">Read More- <a href=\"https:\/\/www.thehindu.com\/opinion\/lead\/fiscal-federalism-efficiency-versus-equity-concerns\/article71310469.ece\" target=\"_blank\" rel=\"noopener\">The Hindu<\/a><br \/>\nUPSC Syllabus- GS 2- Issues related Centre State Relations<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n","protected":false},"excerpt":{"rendered":"<p>Fiscal federalism in India balances resource distribution between the Union and states to ensure cooperative governance. The 16th Finance Commission, chaired by Dr. Arvind Panagariya, retained vertical tax devolution at 41% while introducing performance-driven criteria like GDP contribution. This framework aims to harmonize regional equity, fiscal discipline, and sub-national autonomy for 2026-31. Table of Content&hellip; <a class=\"more-link\" href=\"https:\/\/forumias.com\/blog\/fiscal-federalism-in-india-significance-challenges-explained-pointwise\/\">Continue reading <span class=\"screen-reader-text\">Fiscal Federalism in India &#8211; Significance &#038; Challenges &#8211; Explained Pointwise<\/span><\/a><\/p>\n","protected":false},"author":10391,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"jetpack_post_was_ever_published":false,"footnotes":""},"categories":[130],"tags":[],"class_list":["post-369052","post","type-post","status-publish","format-standard","hentry","category-7-pm","entry"],"jetpack_featured_media_url":"","views":"","jetpack_sharing_enabled":true,"_links":{"self":[{"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/posts\/369052","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/users\/10391"}],"replies":[{"embeddable":true,"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/comments?post=369052"}],"version-history":[{"count":0,"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/posts\/369052\/revisions"}],"wp:attachment":[{"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/media?parent=369052"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/categories?post=369052"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/tags?post=369052"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}