Fiscal Federalism Under Strain: States Demand Greater Autonomy, Challenge Centre's Allocation Policies

Bengaluru, Karnataka – A significant fault line in India’s federal structure is widening, with a growing number of states vociferously demanding greater fiscal autonomy and a more equitable share of central revenues. The pushback, primarily led by opposition-ruled states and particularly prominent in the southern part of the country, signals a brewing political confrontation over the very architecture of economic governance and resource distribution in India. States are alleging that the centralisation of taxation powers, particularly post-GST implementation, combined with the discretionary nature of central grants and a declining share in divisible pools, is crippling their ability to fund crucial development projects and welfare schemes.

Key points

* States are seeking a larger share of the central tax pool, especially challenging the Centre's increased reliance on cess and surcharges which are not part of the divisible pool. * Concerns persist over the cessation of GST compensation and the perceived inadequacy of the Goods and Services Tax framework in empowering states financially. * Apprehensions are rising regarding the conditionalities attached to central grants and the alleged shrinking space for states to determine their own spending priorities. * The debate is intensifying questions about the spirit of cooperative federalism and the autonomy of state governments in policy formulation and implementation. * Southern states like Karnataka, Kerala, and Tamil Nadu are leading the charge, citing significant financial disparities and an erosion of their fiscal independence.

The grievances articulated by state governments are multifaceted, encompassing issues from the structure of the Goods and Services Tax (GST) regime to the recommendations of the Finance Commissions and the increasing reliance on central schemes. State Finance Ministers have consistently pointed out that while their responsibilities, particularly in sectors like health, education, and law and order, continue to expand, their revenue-raising capacity has been severely curtailed. The introduction of GST in 2017, hailed as a landmark reform, unified multiple indirect taxes under a single regime, transferring significant taxing powers from states to the Centre. While initial years saw compensation for revenue shortfalls, its cessation in July 2022 has left several states grappling with financial deficits.

"The GST mechanism, while streamlining taxation, has fundamentally altered the fiscal relationship in favour of the Centre," stated Mr. S. Kumaraswamy, Finance Minister of Karnataka, in a recent press conference. "Our ability to generate own revenues has diminished, and we are increasingly dependent on central transfers, many of which come with strings attached. This is not cooperative federalism; it is fiscal centralisation that undermines the very essence of our federal democracy." Mr. Kumaraswamy highlighted that Karnataka, a significant contributor to the national exchequer, feels it does not receive a commensurate share back, impacting its ambitious development agenda.

Economists largely agree that the issue goes beyond mere numbers and delves into the principles of governance. Dr. Asha Menon, Economist and Senior Fellow at the Centre for Policy Research, Delhi, observed, "The reliance on cess and surcharges by the Union government, which bypass the constitutionally mandated divisible pool, is a particular point of contention. This practice effectively reduces the share of states in overall central tax collections, making them more dependent on discretionary grants rather than their rightful share." Dr. Menon pointed out that this trend impacts fiscal planning at the state level and could lead to sub-optimal public spending outcomes if states cannot tailor policies to local needs.

Official data reveals a stark picture. According to the Comptroller and Auditor General of India (CAG) reports, the share of cess and surcharges in the gross tax revenue of the Union government has steadily increased over the past decade. For instance, in fiscal year 2020-21, cess and surcharges accounted for over 13% of the Centre's gross tax revenues, a significant portion that is not shared with states as per the constitutional scheme for horizontal devolution. The 15th Finance Commission, in its report for the period 2021-26, noted the concerns raised by states regarding cess and surcharges, yet the practice continues. Furthermore, several states have reported significant shortfalls in their projected GST revenues post-compensation period, pushing them towards higher borrowing or austerity measures.

Dr. Raghunath Prasad, former Union Finance Secretary, offered a nuanced perspective. "While states' concerns are valid, the Centre also faces enormous responsibilities, including national defence, major infrastructure projects, and managing macroeconomic stability. Central schemes are often designed to address national priorities and ensure a minimum standard of services across all states. The debate should be about improving the mechanisms for consultation and ensuring transparency, not just an adversarial relationship." He also highlighted that the Finance Commissions' recommendations, while carefully considered, sometimes face implementation challenges due to prevailing economic realities and unforeseen circumstances.

Background

India's fiscal federalism has evolved significantly since independence, guided by successive Finance Commissions. These bodies, constituted every five years, recommend the distribution of tax revenues between the Centre and states (vertical devolution) and among states themselves (horizontal devolution). The introduction of GST in 2017 marked a major overhaul of indirect taxation, subsuming numerous state taxes and making states dependent on the GST Council for revenue decisions. While initially promised five years of compensation for any revenue loss, the expiration of this period in 2022 ignited fresh fears about states' financial health. Coupled with this, states have also voiced concerns over the terms of reference and recommendations of recent Finance Commissions, particularly regarding the use of population data and performance-based grants, which some states argue penalise them for successful population control measures.

What it means

The deepening rift over fiscal autonomy carries profound implications for India’s political stability and economic development. A financially constrained state government may struggle to invest adequately in crucial sectors like health, education, and infrastructure, directly impacting the quality of life for its citizens. It could also lead to increased regional disparities, as wealthier states might be better positioned to manage financial shortfalls compared to less developed ones. Politically, this issue fuels anti-incumbency sentiments at the state level and intensifies Centre-State tensions, potentially leading to increased friction in the GST Council and other inter-governmental forums. It also challenges the foundational principle of cooperative federalism, demanding a re-evaluation of how powers and resources are balanced between the Union and the states.

Reactions

Reactions from various stakeholders have been sharp and varied. Opposition parties have largely rallied behind the states' demands, accusing the central government of systematically eroding state autonomy and concentrating power. "This isn't just about money; it's about the very soul of our democracy," stated a senior leader of an opposition party. Industry bodies, while supporting the GST for its simplicity, have expressed concerns about the potential for policy instability if states remain financially insecure. Ms. Preethi Reddy, Secretary of the Karnataka Chamber of Commerce and Industry, commented, "Businesses thrive on predictability. If states face constant financial uncertainty, it can affect infrastructure development, incentives for investment, and ultimately, economic growth. A stable and predictable fiscal framework for states is crucial for overall economic health."

On the other hand, the central government has defended its policies. Mr. Anil Sharma, National Spokesperson for the ruling party, asserted, "The Union government is committed to the welfare of all states. Our transfers are based on the recommendations of the Finance Commission, a constitutional body, and designed for national cohesion and development. States' claims often overlook the extensive central assistance provided through various schemes and disaster relief. We believe in 'Sabka Saath, Sabka Vikas' (Together with all, Development for all), and that includes strong states within a strong nation." He further suggested that states should also focus on improving their own revenue collection mechanisms and fiscal discipline.

What happens next

The immediate future will likely see continued political jostling, especially with the upcoming general elections. State leaders are expected to intensify their advocacy through public forums, legislative debates, and potentially even legal challenges. The 16th Finance Commission, which is expected to be constituted soon, will have a crucial role in addressing these complex issues, and its terms of reference will be keenly watched. There is a strong possibility that states will push for a comprehensive review of the GST framework, including the possibility of bringing petroleum products and alcohol under its ambit to ensure a more stable and equitable revenue base for them. The outcome of these discussions will not only determine the financial health of states but also shape the political dynamics of Indian federalism for years to come.