Fiscal Federalism refers to the fiscal infrastructure of a country that deals with the assignment of responsibilities and functions to different levels of government, such as the central and state governments. Fiscal order is an important administrative requirement to create a strong inter-governmental fiscal structure through revenue sources. The role of the Finance Commission is to focus on the proper distribution of tax and expenditure authority among the different levels of government. The federal or central government authorizes decisions regarding tax collection, money supply, or borrowing. In contrast, people appoint state governments as service providers in social and economic sectors at the sub-national level.
Constitutional Provisions Relating to Centre-State Fiscal Relations:
| Article | Description |
| Article 246 | Division of taxation powers (now amended under GST). |
| Article 268 | (Duties are levied by the Union, but collection and appropriation are made by the States) |
| Article 269 | (Tax on the sale of goods and tax on consignment of goods). |
| Article 271 | Related to surcharge. Article 275(1) and |
| Article 280 | Order for the formation of the Finance Commission. |
| Article 282 | Grants to the States. |
| Articles 292 and 293 | Definition of borrowing powers by the Union and the States respectively. |
Role of Finance Commission
In India, the Finance Committee was formed with the main responsibility of evaluating the position of finances of the Central and State Governments, deciding on the pattern of sharing of taxes and laying down guidelines for distributing taxes among the States. The role of the Finance Commission includes effective coordination with all levels of government in decision-making thus strengthening the structure of fiscal federalism. The purpose of the Commission’s recommendations is to maintain a balance in public expenditure between the Central and State Governments. The need for a Finance Commission is important to look after the issues related to financial relations between the Central and State Governments.
Duties of Finance Commission
The Commission is entrusted with the authority and responsibility to formulate and implement fiscal policies considering Centre-State financial relations. The role of the Finance Commission is to evaluate the financial position of the states and make suggestions for improvements. In this regard, he felt the need for a Finance Commission to perform the appropriate functions which are as follows:
- Sharing the taxes collected by the central government with the different states.
- Distribution pattern of central taxes in different states.
- Fiscal measures to improve the financial condition of the states.
Role of Finance Commission in Fiscal Federalism
The role of the Finance Committee as an apex body is to exercise control over the sharing and distribution of fiscal powers while addressing issues related to imbalances and inequality. There may be instances where states spend more than the revenue generated. Again, some states have inadequate access to resources due to territorial limitations. Keeping this situation in mind, it recommends guidelines regarding the limit of central funds to be shared by the states to maintain equity in fiscal federalism. The various roles of the Finance Commission in fiscal federalism include the following:
Tax Revenue Sharing
The Commission recommends sharing of central taxes with the states based on some appropriate criteria to reduce disparity among the states which is important for fiscal federalism. The parameters of tax sharing are mentioned as follows:
- Population: The expenditure requirements of a state are determined by its population.
- Area: The administrative cost to be borne by the State will be in proportion to its area.
- Per Capita Income: States with lower per capita income will be eligible to receive higher tax share and grants.
- Economic Activities: Some states may have greater coverage of agricultural land or forests, limiting opportunities for other economic activities, and hence should allocate a greater share to them.
Handling Horizontal Imbalance
The Finance Commission plays an important role in removing the imbalance caused by differences in the extent of financial benefits received by different states. It reviews the growth rate and developmental status of various states and assesses capital requirements. It also makes recommendations for reducing capital deficit and availability of adequate public goods and services.
Addressing Vertical Imbalance
The Finance Commission also takes the responsibility of dealing with the vertical imbalance arising from inequality in the distribution of taxation power among different levels of government (Central Government, State Governments and local bodies). Taxes collected by the central government cover a large area. State governments spend extensively on the development of social and economic sectors at the sub-national level. The role of the Finance Commission is to provide mechanisms in the form of shared tax revenues and grants-in-aid as per requirement.
Review and Progress
An important role of the Finance Commission is to review the impact of the recommendations made by the previous Finance Commission. It felt the need for a Finance Commission to review the financial position of the Central and State Governments and recommend a roadmap for reform and progress. It also studies the impact of new taxes at the central and state levels and on the economy.
Importance of Fiscal Federalism
- Fiscal federalism divides responsibilities concerning taxation and public expenditure among different levels of government, namely the Centre, states and local bodies. Financial independence and adequacy are the foundation of the successful functioning of the federal government.
- It helps government organizations achieve massive cost efficiency in providing public services. The delivery of public services is most closely linked to the preferences of the common people.
- This creates a unified common market. Which promotes macroeconomic activity.
- The Constitution mentions the constitution of the Finance Commission (Article 280) as a key institution responsible for dealing with financial imbalances between the Center and the states as well as within the states.
Road Ahead
- The Center will have to discharge its coordination, corrective and leadership functions in a true federal format.
- States should get a fair share of rights as well as responsibilities.
- A continuous system of communication and clearing should be available.
- The 14th Finance Commission had suggested that outside the recommendations of the Finance Commission, any transfers from the Center to the states should be through a new institutional arrangement (ideally under the aegis of an Inter-State Council). Central, state and regional experts should be included in this system.
- Enforcement of FRBM norms should be made more stringent.
- TOR can be made a joint process by the consortium rather than a top-down process.
Conclusion
The Indian federal system allows the division of power and responsibilities between the Center and the states in financial matters. It includes expenditure, revenue-generating and tax-collection powers. In an effective structure of fiscal federalism, it is very important to provide a balanced distribution of fiscal authority. In general, all levels of administration should be given responsibility for achieving specific goals of fiscal sustainability at the individual level. The role of the Finance Committee as a guide for improving the inter-governmental fiscal structure and efficiency of the economy is quite important.
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