Day 16 – Q. 2. India’s fiscal federalism is facing growing strain due to limited revenue autonomy of States and rising dependence on the Union. Analyse the challenges in this context and suggest measures to strengthen fiscal devolution. (150 words, 10 marks)

Q. 2. India’s fiscal federalism is facing growing strain due to limited revenue autonomy of States and rising dependence on the Union. Analyse the challenges in this context and suggest measures to strengthen fiscal devolution. (150 words, 10 marks)

Introduction 

Fiscal federalism refers to the division of financial powers and responsibilities between the  Centre and States. Articles 268–293 outline this framework. However, falling transfers and  growing revenue dependence are eroding fiscal federal balance and state autonomy. 

Body 

Strain on Fiscal Federalism: Emerging Trends 

1. Declining share in gross tax revenue: States’ fiscal space is weakening as their share of  national taxes reduces. Example: In 2023–24, states got 30% of taxes compared to 35% in 2015–16.
2. Shrinking grants-in-aid: Decline in direct transfers curtails state capacity to fund  development. Example: Central grants fell from ₹1.95 lakh crore in 2021–22 to ₹1.65 lakh crore in 2023– 24. 
3. Erosion of state tax autonomy: GST regime curtailed states’ independent revenue-raising  powers. Example: Since GST began in 2017, states lost control over VAT and key cesses. 

Challenges in India’s Fiscal Federalism 

1. Vertical fiscal imbalance: States spend more than they earn, deepening dependence on the  Union. Example: States incur 58% of public spending but get only 40% of total revenue (2023–24).
2. Rising cess and surcharge centralisation: Centre retains more funds outside the divisible  pool. Example: Cess and surcharge rose from ₹85,638 crore in 2011–12 to ₹3.63 lakh crore in  2023–24. 
3. CSS-driven public spending centralisation: Union controls most schemes while states bear  execution costs. Example: Only ₹4.25 lakh crore of ₹19.4 lakh crore CSS funds devolved to states (2023–24).
4. Conditionality and interstate inequality: Poorer states struggle to match CSS funds,  widening gaps. Example: Wealthier states access CSS better, worsening fiscal imbalance.
5. GST compensation shortfall: End of compensation left states exposed to revenue shocks. Example: Compensation cess ended in June 2022 without a replacement mechanism. 

Measures to Strengthen Fiscal Devolution 

1. Enhance state revenue powers: Empower states to raise more funds by expanding their tax  base. Example: Kerala and others seek inclusion of petroleum and alcohol in GST for greater  control. 
2. Revamp fiscal transfers: Ensure timely and predictable devolution with a higher tax share. Example: Demands for fixed GST payout timelines and revisiting the 41% share are rising  ahead of the 16th Finance Commission. 
3. Rationalize CSS structure: Cut down schemes and give states more untied funds for  flexibility. Example: Punchhi Commission (2010) urged collaborative restructuring to enhance state  discretion. 
4. Strengthen GST Council mechanisms: Improve decision-making through fairer  representation and expert support. Example: 2023 reform talks proposed a permanent secretariat and arbitration body within  the Council.
5. Reinstate Finance Commission’s centrality: Shift from ad hoc transfers to rule-based  funding via the FC. Example: Use of NITI schemes like Aspirational Districts sidestepped FC guidelines, causing  concern. 

Conclusion

Empowering states fiscally is vital to protect India’s federal character. The 16th Finance  Commission must uphold this by ensuring fair, timely, and adequate devolution of resources to  sustain cooperative federalism in both letter and spirit.