Problems: Financial Relations between the Centre and State

After reading this article you will learn about the problems in financial relations between the Centre and State of India with suggestions for balanced fiscal federalism.

1. Mounting Vertical Imbalance:

Vertical imbalance emerges because of disproportionate alignment of revenue sources in relation to increasing expenditure obligations by level of government. There is a situation of growing expenditure requirements and poor yield of revenue source for states in India.


The process of assigning highly elastic revenue to the center and inelastic taxes to the states, led to a high degree of concentration in revenue collection. For example in India the centre collects 59% of total revenue whereas state and local bodies collect 41 % only. Lack of accountability and implementation of populist policies are the major cause for imbalance in state budgets.

2. Horizontal Imbalance:

Various regions and states in India differ in resources endowment, level of development and per capital income. Therefore horizontal imbalance occurs between different units of government at the same level of government in Indian federation.

The resources transfer af­fected through planning commission and Finance Commission has miserably failed in correcting the horizontal imbalance. As a result disparities in per-capita income are increasing.

Very often the discre­tionary grants provided by the centre to the states are influenced by political considerations rather than resource requirement. As a re­sult states are not able to bridge there resource expenditure gap in fiscal operations effectively.

3. Excessive Dependence on Centre:

This situation mainly emerges owing to the existence of vertical im­balance in resources source and transfer. Very often in Indian fed­eration the taxes which are assigned to states are generally less elastic and less productive.

More over the centre has virtual mo­nopoly in two sources of revenue like foreign aid and deficit financ­ing. These sources are not accessible to states. Coupled with this in as per constitutional provision, highly elastic revenue source are under the jurisdiction of the centre.


As a result, with the passage of time states in India have become more and more dependent on cen­tre for financial help. The matter sometimes becomes worse for states ruled by a particular political party different from the one in the cen­tre.

4. Eroded State Autonomy:

It is usually argued that the framers of our constitution were guided by the mistaken notion of “strong centre and weak states”. The single party rule at the centre for the early decades of independence hard­ened this notion.

In addition to this the interference of the centre in the functioning of the state governments has been patronized by the concurrent list which contained around 57 items. Together with this the continued financial dependence of states on centre has increas­ingly eroded the autonomy of states.

In a federation a strong centre without strong states is not feasible. The growing influence of re­gional partners and there active participation in central government coupled with the introduction of structural adjustment programmers, since 1990, has changed the situation. At present we can find quali­tative change in the concept of state autonomy.

5. Overlapping of Functions:


A study report of R. Venkataraman shows that a dualism in the cen­tral assistance has developed and there has been certain overlap­ping of functions of finance commission and the planning commis­sion.

The revenue gap grant is to be made by the finance commis­sion, the plan assistance by planning commission and relief grants by the central government. This in practice revealed that the plan­ning commission encroached in the area of the others in regard to grants.

There has been duplication and overlapping of functions of these institutions. The role and functions of the finance commission as per the provisions of the constitutions can no longer be fully realized, due to emergence of planning commission.

The role of fi­nance commission has been marginalized and reduced to the sta­tus of filling revenue gaps of states. For the healthy growth and sta­bility of a federation, this is not a positive trend.

6. Increasing Debt Burden of States:


Our federal financial system has developed a situation in which the states cannot survive without the central assistance. The use of loans and grants by the state has resulted in financial dependency and indiscipline on the part of the states. This also led to a situation of inevitable debt burden on the part of states.

7. Failure to Reduce Regional Imbalance

The mechanism of central resource transfer has failed to correct horizontal imbalance among states. The disparity in per-capita in­come has been on an increase. The major part of the central transfer of resources, owing to irrational criteria of devolution, went to richer states.

Irrespective of concrete efforts by central government, the regional economic disparity among states could not be removed and inequality of income as between individuals could not be reduced to a significant extend.

Another important factor affecting the decentralized provision of resource transfer is the unsatisfactory status of fiscal tiers below the state level. Constitutionally local bodies (Panchayet Raj Institutions and Municipal Bodies set up recently under and the 73rd and 74th amendment of the constitutions) are not autonomous. They de­rive their powers and resources from state governments.

Suggestions for Balanced Fiscal Federalism:

1. Some Scholars suggest that all current transfers should be af­fected through a permanent Finance Commission and responsi­bility of all central transfers should devolve upon the planning commission.

Prof. V.K.R.V. Rao has argued for placing both the planning commission and Finance commission on a firm statu­tory footing with a clear division of functions and the establish­ment of National Loan Organisation on the lines of Australian Loan Council to effectively administer market borrowing and cen­tral loan to states.

2. To effect purposive and effective transfer of resources a proper co-ordination between the various agencies making transfers i.e., Finance Commission and Planning Commission is to be done. In order to streamline and strengthen Central State Finan­cial relations, these commissions should function in a unified manner with proper understanding.

3. The number of divisible taxes should be increased to enlarge the resource base of the state government.

4. Adequate steps should be undertaken to narrow down the interstate disparities by adopting a deliberate pro-stand in favour of backward states. In the provision of financial assistance due weightage should be given for social and economic backwardness.

5. The state should be given more autonomy in financial matters. It is high time that states be allowed to function without interference from the centre at least in the areas originally specified by the constitution.

The central pillars of federal finance are efficiency, uniformity, economy, autonomy, sufficiency. The central state relations are cru­cial in the preservation and the very existence of federal system. In a Country like India, having linguistic diversity. Cultural Variation, eco­nomic disparity etc., a strong centre patronized by rich and devel­oped states is imperative, for the development of a strong federal state.

The National Development Council, Planning Commission and Finance Commission should be streamlined with objectively and ef­ficiency to strengthen the impulse of Indian fiscal federal relations.

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