Examine the evolving pattern of Centre-State financial relations in the context of planned development in India. How far have the recent reforms impacted the fiscal federalism in India?

Q14. Examine the evolving pattern of Centre-State financial relations in the context of planned development in India. How far have the recent reforms impacted the fiscal federalism in India? (15 Marks,250 Words)

Approach: Introduce with the shift in the fiscal relation between centre and state. IN the main body First write the evolution of the fiscal federalism from Planning commission to the NITI ayog. In the second part write the positive and negative impact of the recent reforms like GST on the fiscal federalism. Conclude with the balanced approach.

Model Answer

Centre-State financial relations in India have shifted from a planned development-driven model to one increasingly influenced by fiscal federalism, with reforms like the Goods and Services Tax (GST) and the Finance Commissions’ recommendations leading to a greater share of taxes being devolved to states

Evolution of the Centre-State Financial Relations

- Planned Development Era: During this period, States grew financially dependent on the Centre, as conditional grants under Centrally Sponsored Schemes dominated fiscal transfers. The Centre controlled planned expenditure, shaping resource allocation more towards national priorities than State-specific needs.
  - E.g. States were heavily dependent on the Centre for financial transfers via Five-Year Plans.
- Market Based development era: Liberalization reduced Centre’s role in micro-planning. States began attracting private investment through competitive federalism.
  - E.g. Industrial corridors and SEZs saw more state-level initiative.

Abolition of Planning Commission (2014): Replaced by NITI Aayog, which has no power of financial allocation. Shifted from “centralized plan transfers” to “Finance Commission-led devolution.”

Finance Commission has evolved significantly in its approach to center-state resource sharing:

Early Commissions (1st-7th): Focused primarily on addressing fiscal gaps and providing basic financial stability to states.
Middle Period (8th-12th): Began incorporating performance incentives and addressing specific developmental challenges.
Recent Commissions (13th-15th): Have progressively increased states’ share in the divisible pool, with the 14th Finance Commission recommending a landmark increase from 32% to 42%.

Impact of recent reforms on fiscal federalism:

Positive impact:

Greater Tax Devolution (14th & 15th Finance Commissions): Share of States in divisible pool increased to 42% (14th FC), retained at 41% (15th FC).

- - It reduced discretionary transfers and increased States’ fiscal autonomy.

Replacement of Planning Commission with NITI Aayog: NITI Aayog promotes cooperative and competitive federalism through consensus-building rather than top-down control.

- E.g. Shift from discretionary “plan grants” to formula-based transfers.
GST and GST Council: It made a unified indirect tax regime with equal participation of Centre & States in decision-making.
- E.g. GST Council acts as a unique example of institutionalized fiscal federalism.
Rationalization of schemes: The restructuring and reduction of centrally sponsored schemes (CSS) provided states with more flexibility in implementation based on their specific needs

Negative Impacts:

GST Compensation Issues

- - Delay in GST compensation (especially post-COVID) eroded trust.
  - States lost some fiscal autonomy, as tax rate decisions are heavily consensus-driven in GST Council.

Rise of Cesses and Surcharges

- - These are not shareable with States under Finance Commission devolution.
  - Shrinks the actual divisible pool, reducing States’ real share below the promised 41%.
- Reduced Flexibility after Abolition of Plan Grants: Though formula-based transfers increased predictability, States argue loss of flexible, need-based funds earlier provided by Planning Commission.

Centrally Sponsored Schemes (CSS)

- - Continue to dominate resource allocation.
  - States compelled to divert resources to CSS priorities, sometimes at cost of their local developmental needs.

Shift to Conditional Transfers:: A growing proportion of grants to states are conditional, tying their spending to Union government priorities and further reducing states’ autonomy in expenditure planning.

Reforms like higher devolution, GST Council, and NITI Aayog have strengthened fiscal federalism by making transfers more rules-based and cooperative. But challenges like cesses, compensation delays, and conditional borrowings continue to weaken States’ autonomy, showing that fiscal federalism in India is still a work in progress.