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  • 20 Aug 2019 GS Paper 3 Economy

    Discuss the need and ways for redefining the fiscal architecture of India to strengthen the fiscal federalism. (250 words)



    • Explain the structure of fiscal federalism in India and how it evolved over a period of time.
    • Mention about imbalances in fiscal federalism and the need to bring reforms.
    • Mention the steps that should be taken as a way forward.


    Federalism is the basic structure of Indian Constitution (SR Bommai Case). India’s asymmetrical model of federalism influences the Centre-State financial relations as well. Centre state financial relations are dynamic and continuously changing as can be observed by steps like devolving 42% of funds to states on the recommendation of 14th Finance Commission, replacing Planning Commission by NITI Aayog, and recently by the introduction of GST.


    However, there are both horizontal and vertical imbalances in fiscal architecture in India:

    • Horizontal imbalance arise because of differing levels of attainment by the states due to differential growth rates and their developmental status in terms of the state of social or infrastructure capital.
    • Vertical imbalance arises due to the fiscal asymmetry in powers of taxation vested with the different levels of government in relation to their expenditure responsibilities prescribed by the constitution.
      • For ex: central government having a far greater domain of taxation (e.g., income taxes personal or corporate, taxing consumption of goods and services (CGST), taxing foreign transactions, etc).
      • Central Government collects around 60% of the total taxes, while its expenditure responsibility (for carrying out its constitutionally mandated responsibility such as defense, etc.) is only 40% of the total public expenditure.
      • Such vertical imbalances are even sharper in the case of the third tier government consisting of elected local bodies and panchayats.

    Suggested reforms

    India’s Fiscal Federalism needs to be restructured around the four pillars namely Finance Commission, NITI Aayog, GST and decentralization in order to eliminate the inadequacies of vertical and horizontal imbalances.

    • Finance Commission must be relieved from the dual task of dealing with provision of basic public goods and services and capital deficits. It should be confined to focussing on the removal of basic public goods imbalance (Type I).
    • NITI Aayog:
      • NITI Aayog should receive significant resources (1% to 2% of the GDP) to remove regional and subregional disparities among states by reducing development imbalances in the areas of infrastructure deficit.
      • NITI should have an Independent Evaluation Office to monitor and evaluate the efficacy of the utilization of revenue and capital grants.
    • Decentralization can serve as the third pillar of the new fiscal federalism :
      • Strengthening local finances by creating a consolidated fund for urban local body/ Panchayati Raj institutions.
      • Centre and States should contribute an equal proportion of their Central GST (CGST) and State GST (SGST) collections and send the money to the consolidated fund of the third tier.
      • State Finance Commissions should be accorded the same status as the Union Finance Commission and the 3Fs of democratic decentralization (funds, functions, and functionaries) should be implemented properly.
    • Goods and Services Tax should be simplified in its structure.
      • Single Rate GST: with suitable surcharges on “sin goods,” zero ratings of exports and reforming the Integrated Goods and Services Tax (IGST) and the e-way bill.
      • Transparency: The GST Council should undertake reforms in an informed and transparent manner, by creating its own secretariat and independent experts.


    Thus, the idea of competitive cooperative federalism in the spirit of ‘Team India’ is the key to achieve good governance and to meet the local aspirations.

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