{"id":92143,"date":"2026-03-11T11:22:51","date_gmt":"2026-03-11T05:52:51","guid":{"rendered":"https:\/\/vajiramandravi.com\/current-affairs\/?p=92143"},"modified":"2026-03-11T12:24:01","modified_gmt":"2026-03-11T06:54:01","slug":"fiscal-federalism-explained","status":"publish","type":"post","link":"https:\/\/vajiramandravi.com\/current-affairs\/fiscal-federalism-explained\/","title":{"rendered":"Fiscal Federalism and the Debate Over the 41% Tax Devolution"},"content":{"rendered":"<h2 style=\"text-align: justify;\"><strong>Fiscal Federalism Latest News<\/strong><\/h2>\n<ul style=\"text-align: justify;\">\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">The Union government\u2019s acceptance of the <\/span><b>16<\/b><b>th<\/b><b> Finance Commission\u2019s recommendation to retain 41% tax devolution to States<\/b><span style=\"font-weight: 400;\"> has sparked debate about the changing nature of fiscal federalism in India.\u00a0<\/span><\/li>\n<\/ul>\n<h2 style=\"text-align: justify;\"><strong>Fiscal Federalism in India<\/strong><\/h2>\n<ul style=\"text-align: justify;\">\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">Fiscal federalism refers to the distribution of financial powers and responsibilities between different levels of government in a federal system.\u00a0<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">In India, fiscal federalism determines how tax revenues are shared between the Union government and the States.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">The Constitution provides a framework for fiscal relations through several provisions:<\/span>\n<ul>\n<li style=\"font-weight: 400;\" aria-level=\"2\"><b>Articles 268-281:<\/b><span style=\"font-weight: 400;\"> These articles govern taxation powers and revenue sharing between the Centre and the States.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"2\"><b>Article 280:<\/b><span style=\"font-weight: 400;\"> Provides for the establishment of the<strong> <a href=\"https:\/\/vajiramandravi.com\/upsc-exam\/finance-commission\/\" target=\"_blank\">Finance Commission<\/a><\/strong> to recommend tax devolution and grants to States.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"2\"><b>7<\/b><b>th<\/b><b> Schedule:<\/b><span style=\"font-weight: 400;\"> Divides taxation powers between the Union List and the State List.<\/span><\/li>\n<\/ul>\n<\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">Since the Union government collects a large portion of taxes, a mechanism is needed to distribute revenue fairly among States. The Finance Commission performs this role by recommending how the divisible pool of central taxes should be shared.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">Over the years, tax devolution to States has increased. The 14<\/span><span style=\"font-weight: 400;\">th<\/span><span style=\"font-weight: 400;\"> Finance Commission raised the States\u2019 share to 42%, which was slightly reduced to 41% by the 15<\/span><span style=\"font-weight: 400;\">th<\/span><span style=\"font-weight: 400;\"> Finance Commission after the reorganisation of Jammu and Kashmir.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">The <\/span><b>16<\/b><b>th<\/b><b> Finance Commission has now recommended continuing the 41% share of the divisible pool for States<\/b><span style=\"font-weight: 400;\">.<\/span><\/li>\n<\/ul>\n<h2 style=\"text-align: justify;\"><strong>Understanding the Divisible Pool<\/strong><\/h2>\n<ul style=\"text-align: justify;\">\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">The divisible pool refers to the portion of central tax revenues that is shared with States.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">However, not all tax revenues are included in this pool. Certain components, such as <\/span><b>cesses and surcharges,<\/b><span style=\"font-weight: 400;\"> are excluded from sharing with States.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">These taxes are levied by the Union government for specific purposes and are retained entirely by the Centre.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">According to Finance Commission data, the share of the divisible pool in gross tax revenues has gradually declined:<\/span>\n<ul>\n<li style=\"font-weight: 400;\" aria-level=\"2\"><span style=\"font-weight: 400;\">During the <\/span><b>13<\/b><b>th<\/b><b> Finance Commission period<\/b><span style=\"font-weight: 400;\">, the divisible pool averaged <\/span><b>89.2% of gross tax revenues<\/b><span style=\"font-weight: 400;\">.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"2\"><span style=\"font-weight: 400;\">During the <\/span><b>14<\/b><b>th<\/b><b> Finance Commission period<\/b><span style=\"font-weight: 400;\">, it fell to <\/span><b>82.1%<\/b><span style=\"font-weight: 400;\">.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"2\"><span style=\"font-weight: 400;\">During the <\/span><b>15<\/b><b>th<\/b><b> Finance Commission period<\/b><span style=\"font-weight: 400;\">, it further declined to <\/span><b>78.3%<\/b><span style=\"font-weight: 400;\">.\u00a0<\/span><\/li>\n<\/ul>\n<\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">This trend suggests that although the States\u2019 share is officially <\/span><b>41%<\/b><span style=\"font-weight: 400;\">, the actual amount transferred may be lower because the base itself has been shrinking.<\/span><\/li>\n<\/ul>\n<h2 style=\"text-align: justify;\"><strong>Recommendations of the 16th Finance Commission<\/strong><\/h2>\n<ul style=\"text-align: justify;\">\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">The 16<\/span><span style=\"font-weight: 400;\">th<\/span><span style=\"font-weight: 400;\"> Finance Commission examined the fiscal position of both the Union and State governments and proposed several recommendations regarding tax sharing and fiscal discipline.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">The Union government accepted several key recommendations, including:<\/span>\n<ul>\n<li style=\"font-weight: 400;\" aria-level=\"2\"><span style=\"font-weight: 400;\">Retaining <\/span><b>41% tax devolution<\/b><span style=\"font-weight: 400;\"> to States<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"2\"><span style=\"font-weight: 400;\">Accepting the <\/span><b>horizontal distribution formula among States<\/b><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"2\"><span style=\"font-weight: 400;\">Approving <\/span><b>local body grants<\/b><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"2\"><span style=\"font-weight: 400;\">Supporting the <\/span><b>disaster management funding framework<\/b><span style=\"font-weight: 400;\">\u00a0<\/span><\/li>\n<\/ul>\n<\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">However, several structural reforms proposed by the Commission were deferred. These include:<\/span>\n<ul>\n<li style=\"font-weight: 400;\" aria-level=\"2\"><span style=\"font-weight: 400;\">Reform of <\/span><b>Fiscal Responsibility Legislation (FRL)<\/b><span style=\"font-weight: 400;\"> frameworks<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"2\"><span style=\"font-weight: 400;\">Regulation of <\/span><b>off-budget borrowings<\/b><span style=\"font-weight: 400;\"> by States<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"2\"><span style=\"font-weight: 400;\">Reforms in the <\/span><b>power sector distribution companies (DISCOMs)<\/b><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"2\"><span style=\"font-weight: 400;\">Rationalisation of subsidies<\/span><\/li>\n<\/ul>\n<\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">The Union government indicated that these issues would be examined separately at a later stage.<\/span><\/li>\n<\/ul>\n<h2 style=\"text-align: justify;\"><strong>Structural Issues in State Finances<\/strong><\/h2>\n<ul style=\"text-align: justify;\">\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">The Finance Commission\u2019s analysis highlights growing fiscal stress in several States.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">For instance:<\/span>\n<ul>\n<li style=\"font-weight: 400;\" aria-level=\"2\"><span style=\"font-weight: 400;\">Punjab\u2019s debt-to-GSDP ratio reached 42.9% in 2023-24, along with a revenue deficit of 3.7% of GSDP.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"2\"><span style=\"font-weight: 400;\">Rajasthan\u2019s liabilities stood at 37.9% of GSDP.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"2\"><span style=\"font-weight: 400;\">West Bengal recorded liabilities of 38.3% of GSDP.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"2\"><span style=\"font-weight: 400;\">Andhra Pradesh had liabilities of about 34.6% of GSDP.\u00a0<\/span><\/li>\n<\/ul>\n<\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">In some cases, borrowing is used primarily to meet revenue expenditure, such as salaries and interest payments, rather than to create productive capital assets.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">Another concern is <\/span><b>off-budget borrowing<\/b><span style=\"font-weight: 400;\">, where States borrow through government-controlled entities and repay the loans using public funds. This practice keeps liabilities outside official fiscal deficit figures.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">The Finance Commission recommended tighter regulation of such borrowing practices, but implementation has been deferred.<\/span><\/li>\n<\/ul>\n<h2 style=\"text-align: justify;\"><strong>Changes in the Horizontal Devolution Formula<\/strong><\/h2>\n<ul style=\"text-align: justify;\">\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">The Finance Commission also revised the formula used to distribute funds among States.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">Previously, a portion of transfers depended on <\/span><b>tax and fiscal effort<\/b><span style=\"font-weight: 400;\">, which rewarded States that improved their tax collection efficiency relative to their economic capacity.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">Under the new formula, this criterion has been replaced by a <\/span><b>\u201ccontribution to GDP\u201d indicator<\/b><span style=\"font-weight: 400;\">, which carries a weight of <\/span><b>10%<\/b><span style=\"font-weight: 400;\"> in the allocation formula.\u00a0<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">This shift benefits economically stronger States such as Maharashtra, Gujarat, and Karnataka.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">These States contribute significantly to the national GDP and already have relatively strong fiscal capacity.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">On the other hand, poorer States such as <\/span><b>Bihar, Jharkhand, and Uttar Pradesh<\/b><span style=\"font-weight: 400;\">, which rely more heavily on central transfers, may benefit less from this criterion.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">Critics argue that this change weakens the principle of <\/span><b>fiscal equalisation<\/b><span style=\"font-weight: 400;\">, which traditionally aimed to help less developed States.<\/span><\/li>\n<\/ul>\n<h2 style=\"text-align: justify;\"><strong>Local Body Grants and Conditionalities<\/strong><\/h2>\n<ul style=\"text-align: justify;\">\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">Another major component of the Finance Commission transfers involves grants to local governments.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">The Sixteenth Finance Commission recommended <\/span><b>Rs. 7,91,493 crore in grants for rural and urban local bodies<\/b><span style=\"font-weight: 400;\">.\u00a0<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">These grants are divided into two categories:<\/span>\n<ul>\n<li style=\"font-weight: 400;\" aria-level=\"2\"><b>Basic grants<\/b><span style=\"font-weight: 400;\"> &#8211; Provided to support essential services and administrative functions of local governments.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"2\"><b>Performance grants<\/b><span style=\"font-weight: 400;\"> &#8211; Provided only if certain conditions are met, such as:<\/span>\n<ul>\n<li style=\"font-weight: 400;\" aria-level=\"3\"><span style=\"font-weight: 400;\">Timely constitution of State Finance Commissions<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"3\"><span style=\"font-weight: 400;\">Maintenance of audited accounts<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"3\"><span style=\"font-weight: 400;\">Compliance with central data reporting systems<\/span><\/li>\n<\/ul>\n<\/li>\n<\/ul>\n<\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">While these conditions aim to improve governance, some analysts argue that they may disproportionately affect States with weaker administrative capacity.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"1\"><span style=\"font-weight: 400;\">During the previous Finance Commission period, only about 62.6% of recommended urban local body grants were actually released, indicating implementation challenges.<\/span><\/li>\n<\/ul>\n<h2 style=\"text-align: justify;\"><strong>Implications for India\u2019s Fiscal Federalism<\/strong><\/h2>\n<ul>\n<li style=\"font-weight: 400; text-align: justify;\" aria-level=\"1\"><span style=\"font-weight: 400;\">The recent developments reflect broader trends in India\u2019s fiscal federal system.<\/span><\/li>\n<li style=\"font-weight: 400; text-align: justify;\" aria-level=\"1\"><span style=\"font-weight: 400;\">Three key implications emerge:<\/span>\n<ul>\n<li style=\"font-weight: 400;\" aria-level=\"2\"><b>Growing Centre-State asymmetry<\/b><span style=\"font-weight: 400;\">: Increasing reliance on cesses and surcharges allows the Union government to retain a larger share of tax revenues.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"2\"><b>Shift in allocation principles<\/b><span style=\"font-weight: 400;\">: Greater weight to GDP contribution may favour richer States over poorer ones.<\/span><\/li>\n<li style=\"font-weight: 400;\" aria-level=\"2\"><b>Delayed structural reforms<\/b><span style=\"font-weight: 400;\">: Important issues such as fiscal discipline rules and power sector reforms remain unresolved.<\/span><\/li>\n<\/ul>\n<\/li>\n<li style=\"font-weight: 400; text-align: justify;\" aria-level=\"1\"><span style=\"font-weight: 400;\">Together, these trends may gradually reshape fiscal relations between the Union and the States.<\/span><\/li>\n<\/ul>\n<p><b>Source:<\/b> <strong><a href=\"https:\/\/www.thehindu.com\/news\/theillusion-of-41andaquietre-engineering-ofindiasfiscalfederallandscape\/article70726565.ece#:~:text=An%20Explanatory%20Memorandum%20issued%20by,of%20what%20it%20does%20not.\" target=\"_blank\" rel=\"nofollow noopener\">TH<\/a><\/strong><\/p>\n","protected":false},"excerpt":{"rendered":"<p>Fiscal Federalism debate has intensified after the 16th Finance Commission retained the 41% tax devolution.<\/p>\n","protected":false},"author":21,"featured_media":92151,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[18],"tags":[5998,60,22,59],"class_list":{"0":"post-92143","1":"post","2":"type-post","3":"status-publish","4":"format-standard","5":"has-post-thumbnail","7":"category-upsc-mains-current-affairs","8":"tag-fiscal-federalism","9":"tag-mains-articles","10":"tag-upsc-current-affairs","11":"tag-upsc-mains-current-affairs","12":"no-featured-image-padding"},"acf":[],"_links":{"self":[{"href":"https:\/\/vajiramandravi.com\/current-affairs\/wp-json\/wp\/v2\/posts\/92143","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/vajiramandravi.com\/current-affairs\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/vajiramandravi.com\/current-affairs\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/vajiramandravi.com\/current-affairs\/wp-json\/wp\/v2\/users\/21"}],"replies":[{"embeddable":true,"href":"https:\/\/vajiramandravi.com\/current-affairs\/wp-json\/wp\/v2\/comments?post=92143"}],"version-history":[{"count":3,"href":"https:\/\/vajiramandravi.com\/current-affairs\/wp-json\/wp\/v2\/posts\/92143\/revisions"}],"predecessor-version":[{"id":92164,"href":"https:\/\/vajiramandravi.com\/current-affairs\/wp-json\/wp\/v2\/posts\/92143\/revisions\/92164"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/vajiramandravi.com\/current-affairs\/wp-json\/wp\/v2\/media\/92151"}],"wp:attachment":[{"href":"https:\/\/vajiramandravi.com\/current-affairs\/wp-json\/wp\/v2\/media?parent=92143"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/vajiramandravi.com\/current-affairs\/wp-json\/wp\/v2\/categories?post=92143"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/vajiramandravi.com\/current-affairs\/wp-json\/wp\/v2\/tags?post=92143"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}