Financial Relation Between Centre And State In India

The Financial relationship between the Centre (Union) and the States is provided in the constitution. The constitution gives a detailed scheme of distribution of financial resources between Union and the States.

The Indian constitution makes a broad distinction between the power to levy a tax and the power to appropriate the proceeds of a tax. Thus, the legislature which levies a tax is not necessarily the authority which retains the proceeds of a tax levied.

The constitution grants the Union Parliament exclusive power to levy taxes on several items. The state legislatures enjoy similar power with regard to several other specified items. In general, the Union Parliament levies taxes on items mentioned in the union list while the state legislatures levy taxes on items mentioned in the state list.

The subjects on which the union government have the exclusive powers to levy taxes are:

  1. customs duty,
  2. corporation tax,
  3. capital gains,
  4. surcharge on income tax,
  5. railway fares etc.

State’s exclusive power to Tax include:

  1. land revenue
  2. stamp duty,
  3. estate duty,
  4. agricultural income,
  5. entry tax,
  6. sales tax,
  7. taxes on vehicles and luxuries etc.

The residuary power of taxation belongs to the centre. It means that the subjects which have not been included either in the union or in the state list may be taxed only by the union government.

In the matter of taxation, the constitution recognizes no concurrent jurisdiction. Hence there is no subject who may be taxed both by the union and the state governments.

Besides the exclusive power of taxation of the union and the state governments, there are 3 other categories of taxes.

  1.  Taxes levied by the union government but collected and appropriated by the states. Stamp duties on bills of exchange, excise duties on medicinal and toilet preparations fall in this category.
  2. Secondly, certain duties are levied and collected by the union but the net proceeds of such taxes are distributed among the states. Each state gets that amount of the tax as is collected within its territory. Succession duty, estate duty on property other than agricultural land, taxes on railway fares and freights, taxes on newspaper sales and advertisements etc. fall in this category.
  3.  Thirdly, certain taxes are levied and collected by the union but the proceeds are distributed between the centre and the states. Taxes on non-agricultural incomes (Art. 270) and excise duties on items in the union list accept medicinal and toilet preparations, fall in this category.

In this scheme of resource distribution, the central government in India, indeed in every federation has more money than it needs. This is because,  the central government is the government at a distance whereas the state governments are the governments at hand to the people. The most productive sources of revenue in every federation are with the centre while the most expensive heads of expenditure are with the states. For the State Governments are directly responsible for the maintenance of law and order and are charged with the responsibility of carrying on welfare activities such as education, health care, etc. consequently the states have less revenue incomes than they need. This makes the states financially dependent on the centre which the ruling party at the centre may use to serve its political ends.

To relieve this dependence, the constitution provides for grants-in-aid to the states. Parliament decides which states are in need of grants-in-aid. Art. 275 of the constitution provides for grants-in-aid to some states for the promotion of welfare of the tribal people. States also receive grants-in-aid in cases of natural calamities like floods or draughts.

The constitution provides for constitution of a Finance Commission to advice the President on distribution of financial resources between the Union and the States. A Finance Commission is appointed every five years. The first Finance Commission submitted its report in 1952. The Finance Commission advises the President, what percentage of the income tax should be retained by the centre, and what principles should be adopted to distribute the divisible pool of the income tax among the states. The commission also advises the President on the question of grants-in-aid to be given to the states.

The scheme of division of financial resources adopted in India is certainly very complicated. It also has the effect of making the states financially dependent on the centre. Such a scheme is certainly corrosive of autonomy of the states. States should be given more financial autonomy than is given now to make their political autonomy real.