Financial relations between the Centre and states are given in articles 268 to 280 of the Constitution of India. Financial relations between the union and the states are derived from the Government of India Act, of 1935. The areas of taxation have been clearly demarcated between the centre and states. The states have little power in taxation and are heavily dependent on the centre, for financial resources. The chief source of finance of the states is the grants-in-aid from the Centre. The central-state financial relationship has undergone substantial changes after the passage of the 101st amendment which introduced the Goods and Services Tax (GST) in India. The UPSC Indian Polity and Governance Syllabus includes Financial Relations Between Centre and States which is described in this article.

Financial Relation Between Centre And States - Constitutional Provisions

Article 268

• Article 268 deals with stamp duty levied by the Union but collected and distributed by the States.
• These taxes are not included in the Consolidation Fund of India and are allocated to the state in which they are levied, so they do not contribute to the Indian Consolidation Fund.
• With the 88th amendment to the Constitution, a new provision 268 A was included in this article, which included the tax on services in its ambit, but it was again excluded by the 101st Amendment to the Constitution with the introduction of GST.

Article 269

• Taxes on the sale or purchase of Goods in the course of inter-state trade.
• Taxes on the consignment of goods in the course of inter-state trade or commerce.
• They are assigned to the concerned states. Therefore net proceeds of these taxes do not form a part of the consolidated fund of India.

Article 269 A

The 101st Constitutional Amendment introduced a new provision 269A, which introduced a number of significant changes.

Article 269A (1) mainly deals with the following aspects:

Taxation and collection of tax on goods and services (GST).

• This is applicable in the case of Inter-state trade or commerce.
• The collected taxes will be distributed between the states and the Union.
• Parliament has the power to pass legislation on the distribution of taxes levied in accordance with this article, in accordance with the recommendations of the GST Council.
• Goods and Services Tax (GST) on supplies in interstate trade or commerce levied and collected by the Center; however, the net proceeds is divided between the Center and the states, as in manner provided by parliament in accordance with the recommendations of the GST Council.
• Parliament is also empowered to develop guidelines for where and when the supply of goods or services, or both, takes place in the course of interstate trade or commerce.

Article 270

Taxes are collected and levied by the Center but the net proceeds are allocated between the Center and the states (Article 270) on the recommendation of the Finance Commission.

This category includes all taxes and levies mentioned in the List of the Union, with the exception of the following:

• Duties and taxes are referred to in Articles 268, 269 and 269 A.
• Surcharges on taxes and duties referred to in Article 271.
• Any levies received for specific purposes.
• The 101st Amendment added two new sub-clauses, Section 270 (1A) and 270 (1B) under this Article. The tax allocated between the Center and the state was revised after the introduction of the GST.

Article 271

• Parliament has the right to levy the surcharges on taxes and duties referred to in Articles 269 and 270.
• The proceeds of such surcharges go to the Centre exclusively ie.states have no share in these surcharges.
• Surcharge can not be imposed on GST.

Distribution Of Non-tax Revenues

1. The Centre – receipts from Posts & telegraphs, Banking Railways, Broadcasting, Coinage & currency, Escheat & lapse.
2. The States – receipts from Irrigation, Forests, Fisheries, State PSE, Escheat & lapse

How States Get Grant-in-aids From The Centre?

• In addition to the distribution of taxes between the Center and the states, there are several provisions in the Constitution that regulate the scope for Grants-in-aid.
• In accordance with Article 275 and 282, Parliament may provide grants-in-aid from the Consolidation Fund of India to states which are in the need of financial assistance.
• Constitution also provide for specific grants for promoting the welfare of the Scheduled tribes.Eg.special grant for Assam.

Statutory Grants

• Statutory grant is provided in Article 275 of the Indian Constitution.
• Parliament provides these grants to specific states that need assistance.
• This article sets different grants for different states.
• Amount transferred from India Consolidated Fund.
• There are two conditions for granting aid to the states for any development plan approved by the Indian government for the benefit of the Scheduled areas and Scheduled tribes, with a particular focus on Assam.
• Any parliamentary regulation relating to Grants-in-aid as specified is subject to prior recommendation by the Finance Committee.

Discretionary Grants

• In accordance with Article 282, the Center may, at its discretion, provide assistance to certain states for public purposes.
• These Grants are optional, not compulsory in nature.
• The Center previously issued these grants on the recommendation of a planning commission.
• Moreover, during the period of the planning commission, the general discretionary grants were even higher than the statutory grants.

Other Grants

• Grants for a temporary period
• Grants provided in lieu of export duties on jute & jute products to the states of Assam, Bihar, W. Bengal & Orissa.
• Charged on Consolidated Fund
• Recommended by FC

Finance Commission - Article 280

• The Finance Committee, established in 1951 in accordance with Article 280 of the Constitution.
• It mainly determines how net proceeds of taxs is distributed between the Center and the States.
• In addition, the Commission also determines the principles for grants-in-aids to states.
• Article 280 regulates the Finance Commission, a quasi-judicial body established by the President.

FC Recommends To The President

• Allocation, Respective shares and Distribution of net tax proceeds among Centre and State.
• Principles that will guide Grants in Aid by the Center to the states.
• Measures necessary to increase the Consolidation Fund
• Any other issues proposed by the President

GST Regime - 101st Amendment to the Constitution

• Goods and Services Tax (GST) is an indirect tax introduced in India on July 1, 2017, and applied throughout India, replacing the tiered taxes levied by the central government and the state.
• It was passed as the Constitution (One Hundred and First Amendment) Act, 2016, following the passage of the 122nd Constitutional Amendment Bill.
• According to the GST, goods and services are taxed at the following rates: 0%, 5%, 12%, 18% and 28%.
• GST is classified as CGST, SGST, or IGST depending on whether the transaction is for intrastate or interstate delivery.

Protection Of Interest Of The States

To protect the interests of states in financial matters, the Constitution provides that the following bills may be submitted to parliament only on the recommendation of the president:

• A bill to introduce or replace any tax or duty in which the states are interested;
• A Bill to amend the meaning of the term “farm income” as defined for the purposes of the enactment relating to Indian Income Tax;
• A bill affecting the principle by which money is distributed or can be distributed among states; and
• A bill for the surcharge of any taxes or duty specified for the purposes of the Center.

Effects Of Emergencies

During National Emergency

• The President in National Emergency can order the suspension of all grants received by states from the Union.
• This suspension is, however, temporary and cannot exceed the period of the fiscal year in which the emergency declaration expires.

During Financial Emergency

• The financial relations of the centre-state change significantly in the event of a financial emergency under Article 360.
• In such cases, the Center becomes very powerful and exercises great control over states, forcing them to comply with certain rules regarding financial property and providing other important guarantees.

The Central government can issue the following directives to the state

• Comply with special provisions on financial assets;
• Reduce salaries and allowances for all class of persons serving in the state, including high court judges.
• To reserve all money bills and other financial bills for consideration by the President.

Conclusion

Financial Relations between centre and states have evolved over the years to strike a balance between the fiscal autonomy of the States and the overarching need for national economic cohesion. The recommendations of various Finance Commissions have aimed at ensuring a fair distribution of resources, promoting fiscal discipline, and addressing the diverse needs of different states.

FAQs

Q1: What are the key provisions of financial relations between the Centre and States in India?

Q2: How are taxes shared between the Centre and the States?

Q3: What is the role of the Finance Commission in Centre-State financial relations?

Q4: How does the Goods and Services Tax (GST) impact Centre-State financial relations?

Q5: Can the Centre borrow money on behalf of the States?

MCQs

1. Under which Article of the Constitution is the Finance Commission constituted?

a) Article 356

b) Article 275

c) Article 280

d) Article 324

2. Which of the following taxes is shared between the Centre and the States?

a) Custom duties

b) Corporation tax

c) Income tax

d) GST

3. What is the primary role of the Finance Commission?

a) Levy taxes

b) Allocate resources between Centre and States

c) Collect taxes

d) Impose fines

4. Which Article deals with the distribution of revenues between the Centre and the States?

a) Article 270

b) Article 280

c) Article 356

d) Article 262

5. Which of the following statements is correct regarding GST?

a) It is collected solely by the Centre

b) It is a tax only on goods

c) It is shared between Centre and States

d) It is applicable only to services

GS Mains Questions and Model Answers

Q1. Discuss the financial relations between the Centre and the States under the Indian Constitution.

Answer: The financial relations between the Centre and the States in India are primarily governed by Articles 268 to 293 of the Constitution. The Centre collects and shares certain taxes with the States, such as income tax and central excise, based on the recommendations of the Finance Commission (Article 280). The Finance Commission plays a pivotal role in determining the distribution of financial resources and recommending grants-in-aid for States in need. The introduction of GST has further redefined Centre-State financial relations by creating a common tax system. While the States have significant financial responsibilities, the Centre retains considerable control over revenue distribution, ensuring that national fiscal policies are effectively implemented. The dynamic relationship between the Centre and the States is essential for fiscal federalism in India.

Q2. Evaluate the role of the Finance Commission in ensuring fiscal federalism in India.

Answer: The Finance Commission, established under Article 280, plays a crucial role in maintaining fiscal federalism by recommending the division of financial resources between the Centre and the States. It ensures that States receive a fair share of central taxes to carry out their responsibilities effectively. The Commission also proposes grants-in-aid to assist weaker States in meeting their financial needs. By ensuring an equitable distribution of resources, the Finance Commission promotes balanced economic growth across the country. Its recommendations help maintain financial discipline, avoid regional disparities, and ensure that States can fulfill their developmental and welfare obligations while maintaining the unity of the federal structure.

Q3. Analyze the impact of the Goods and Services Tax (GST) on Centre-State financial relations.

Answer: The introduction of the Goods and Services Tax (GST) in 2017 marked a significant shift in Centre-State financial relations. GST replaced multiple indirect taxes, creating a unified tax system that is jointly administered by the Centre and the States. Under this system, both the Centre and the States share the revenues collected under GST, fostering cooperation between them. The GST Council, a constitutional body, was established to ensure smooth coordination between the Centre and the States on tax-related matters. While GST has simplified the tax structure and improved revenue collection, it has also required adjustments in the financial autonomy of States, as they now depend more on their share of GST revenue. Overall, GST has strengthened fiscal federalism by promoting a more coordinated and transparent tax regime.

Previous Year Questions on  Financial Relations

1. UPSC CSE Mains 2018

Question. How does the Finance Commission help in the distribution of financial resources between the Centre and the States?

Answer: The Finance Commission, constituted under Article 280 of the Indian Constitution, plays a vital role in recommending the distribution of tax revenues between the Centre and the States. The Commission is tasked with reviewing the financial position of both the Centre and the States and making recommendations regarding the division of net proceeds of taxes, particularly those that are shared between the two levels of government. It also determines the principles governing grants-in-aid to the States and ensures that resources are allocated equitably to maintain financial stability across the country. The Commission’s recommendations help address regional disparities and ensure that States with weaker fiscal capacities receive adequate support from the Centre. By maintaining a balance between the financial autonomy of States and the need for centralized control over resources, the Finance Commission strengthens the federal structure of the country.

2. UPSC CSE Mains 2019

Question. What has been the impact of the Goods and Services Tax (GST) on the financial relations between the Centre and the States?

Answer: The introduction of the Goods and Services Tax (GST) has significantly impacted the financial relations between the Centre and the States in India. GST, which subsumes various indirect taxes like VAT, excise duty, and service tax, is jointly collected by both levels of government. This cooperative tax system has resulted in a greater level of interdependence between the Centre and the States, as they now share the revenues generated from GST. The GST Council, comprising representatives from the Centre and all States, is responsible for making key decisions regarding tax rates, exemptions, and other important matters related to GST. This has fostered greater cooperation and dialogue between the Centre and the States. However, some States have expressed concerns over the potential loss of fiscal autonomy, as they are now more reliant on GST compensation provided by the Centre. Despite these challenges, GST has contributed to a more streamlined and transparent tax system, benefiting both the Centre and the States in the long run.
 

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