Indian Fiscal Federalism: Key Aspects and Challenges

Study Notes

Indian Fiscal Federalism

Federalism is a system of government where power is shared between central authorities and local units. In India, fiscal federalism refers specifically to how this sharing of powers works when it comes to taxation and expenditure within the country's three layers of government - union (national), state, and local. This relationship has been described as complex due to the variation in the financial capacity of states and their ability to raise taxes locally. Here's a closer look at the key aspects of Indian fiscal federalism:

Central Government Revenue Collection and Allocation

The dominant source of revenue collection lies with the Union Government, which collects revenues primarily through indirect taxes like customs duties, excise duties on manufactured goods, service tax, and corporation tax. These collections account for approximately two-thirds of total public sector receipts. A significant amount from these resources goes towards transfer payments to the States, known as devolution, based on certain specified criteria such as population size, income levels, area and forest coverage, literacy rate, etc.. Additionally, there are specific grants given by the Center to States for various schemes, also termed plan assistance.

State Governments Revenue Generation and Expenditure

States have limited direct taxing powers, relying mostly on sales tax, entertainment tax, property tax, stamp duty, water cesses, electricity charges, and professions tax. However, they enjoy some latitude in generating funds via debt creation and borrowings under certain conditions. On the spending side, States bear responsibility for most social services including education, health, urban infrastructure development, agriculture extension activities, rural housing, etc., although a portion of these expenses can still come from divisible pool transfers from the Centre.

Local Bodies and Finance Administration

Local bodies, namely municipal corporations and district councils, cannot levy any form of direct taxation and depend solely upon revenues derived from non-tax sources such as user fees, advertisement charges, land value taxation, and others. They receive a share of the proceeds from centrally collected taxes along with relevant grants, which covers roughly 70% to 80% of their annual requirements. Unfortunately, many local governments lack even basic facilities to govern effectively, leading to issues around accountability and efficiency.

Issues and Challenges

One major issue stemming from fiscal federalism in India is the perennial problem of vertical imbalance—a situation where the requirement of states exceeds their resource generation potential. This gap is partially filled up via intergovernmental transfers, making the center vital for maintaining economic stability within the federation. Furthermore, the Union Government's monopoly over certain taxes, particularly those related to important industries, constitutes another point of concern because it gives them a degree of control over the economy. Lastly, the practice of conducting large number of transactions outside the formal banking channels poses challenges to efficient tax administration at all levels of government.

In conclusion, despite its shortcomings, the current structure ensures that essential functions are carried out efficiently across different tiers of government while providing flexibility for both the Centre and States to manage their finances independently according to local needs and circumstances.

Description

Explore the intricate system of fiscal federalism in India, focusing on the division of taxation and expenditure powers among the central, state, and local governments. Learn about revenue collection, allocation, and key issues faced in maintaining financial balance across different tiers of governance.