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Introduction

India’s federal structure rests on a delicate fiscal balance between the Union and the States. However, rising centralisation through cesses, surcharges, and borrowing constraints has eroded States’ fiscal autonomy, weakening both cooperative and competitive federalism envisioned by the Constitution.

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How Cooperative Federalism is Undermined by Growing Fiscal Imbalance

• Centralisation of Taxation Powers: The introduction of GST shifted major taxation powers from States to the GST Council, where the Centre holds greater influence, reducing States’ say in fiscal decisions.
  Eg: Post-GST, States lost key revenue sources such as octroi, entry tax, and local surcharges.
• Declining Tax Devolution: Despite Finance Commission recommendations, the actual share of gross tax revenue devolved to States has been consistently below the promised 41%.
  Eg: Rising cesses and surcharges, which are non-shareable, have reduced States’ real revenue share.
• Dependence on Central Transfers: States rely heavily on Central grants, making them vulnerable to policy delays or political biases in fund allocation.
  Eg: Central transfers form over 44% of State revenue, going up to 72% for Bihar.
• Reduced Fiscal Autonomy: The increasing number of Centrally Sponsored Schemes (CSS) on State subjects limits flexibility in resource utilisation.
  Eg: Expansion of CSS in health and education has increased expenditure burdens without commensurate autonomy.
• Weak Institutional Mechanisms: Dominance of the Centre in Finance Commission criteria and GST Council decision-making erodes the spirit of equal partnership.
  Eg: States’ concerns about being penalised for better performance in tax efficiency and population control.

How Competitive Federalism is Undermined by Growing Fiscal Imbalance

• Unequal Resource Base: Richer States generate more revenue but receive proportionally less in Central transfers, limiting their capacity for competitive growth.
• Distorted Incentives: Overdependence on Central grants discourages States from improving their own tax mobilisation.
• Fiscal Uncertainty: Unpredictable flow of Central funds hinders States’ long-term planning and competitiveness.
  Eg: Delay in GST compensation payouts caused liquidity crises in several States during COVID-19.
• Reduced Policy Experimentation: States have limited space to design context-specific fiscal policies or welfare schemes.
• Political Centralisation: Fiscal dependency weakens States’ bargaining power, creating political imbalances that affect cooperative competition.
  Eg: Opposition-ruled States often allege discriminatory treatment in fiscal allocations.

Suggestive Measures to Enhance Fiscal Autonomy of States

• Reform GST Structure: Introduce greater State voting parity in the GST Council and restore select State-level taxes to diversify revenue bases.
• Merge Cesses and Surcharges into the Divisible Pool: This will ensure equitable sharing of total Central revenues and increase predictability of State income.
• Empower States to Levy Surcharges or Top-Up Taxes: Allowing States to impose a marginal surcharge on personal income tax or GST can enhance fiscal flexibility.
• Revise Finance Commission Criteria: Introduce a stable formula rewarding fiscal responsibility and innovation, while reducing political discretion in transfers.
• Promote Fiscal Transparency and Decentralisation: Institutionalise regular Centre-State fiscal dialogues and independent monitoring of fund allocation and utilisation.

Conclusion

The erosion of States’ fiscal space weakens both cooperative and competitive federalism, undermining India’s constitutional balance. Empowering States with predictable, transparent, and flexible revenue mechanisms is essential for a stronger, self-reliant federal system. Restoring fiscal trust through decentralised decision-making will reinvigorate India’s federal compact.

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