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Day 11 – Q 5.Analyse the manner in which the dynamics of interstate and centre-state relations affect the larger objective of sustained economic growth.

5. Analyse the manner in which the dynamics of interstate and centre-state relations affect the larger objective of sustained economic growth.  

अंतरराज्यीय और केंद्रराज्य संबंधों की गतिशीलता जिस तरह से निरंतर आर्थिक विकास के बड़े उद्देश्य को प्रभावित करती है, उसका विश्लेषण करें।


A federal set up is considered to be an optimal form of government as it combines the strength of a unitary as well as a decentralized form of government. The essence of federalism lies in proper division of powers and functions among various levels of government to ensure adequate financial resources to each level of government to enable them to perform their exclusive functions.


Manner in which dynamics of interstate and Center-state relations affect the larger objective of sustained economic growth.   

  • The most important aspect of fiscal federalism is the division of resources and functions between different levels of governments. The existence of fiscal imbalances is inherent in most of the federations since the division of resources goes in favour of the central government to achieve the objectives of stabilization and distribution. Similar is the case of Indian federalism where there is a mismatch of resources and expenditure responsibilities at different layers of government. 

  • The transfers from Centre to States take place through Union Finance Commission (UFC), GST and Central Ministries, of which the transfers from FC are predominant. Gross devolution and transfers (GDT) comprises of States’ share in central taxes (SCT), grants-in-aid and gross loans from center. 
  • The dependence of states on Central transfers varies depending on the capacity of the states to generate own resources. For high income states it varies from one-fourth to one-sixth of their revenues, for middle-income states between one-third to one-fifth (except for Chhattisgarh and West Bengal where dependency is much higher, almost 40-50%) and for low-income states it is quiet high ranging from 42-80%. In case of Special Category States, these Central transfers are very high varying from 64.98% to almost 93% of their revenue receipts. Haryana is the least dependent State on central transfers, followed by Punjab, Maharashtra, Gujarat and Goa. Given the need of the states, FC has been trying to transfer more resources to the States. For example, the share of the States in the net proceeds of central taxes and duties have increased from 29.5% in 11th FC to 42% in 14th FC.
  • The participation of all States and Centre in the framing of GST laws has led to Harmonisation of GST laws across the country, Common Compliance Mechanism, Cross Empowerment of Officers of Centre as well as States.

Issues between Centre and States 

  • With the inception of economic reforms in 1991, the responsibility of the States has gone up substantially in meeting the increasing need of the basic services of the people. Over the years, the center has become stronger in terms of higher revenue potential while states got burdened with greater functional responsibilities in the areas of education, health, economic and social infrastructure, social security and welfare. This has increased vertical fiscal imbalance and also horizontal fiscal imbalances due to differential performance of the states during post-reforms period. As a result inequality across the states and within the states has increased with respect to providing public services. 

  • Further, the enactment of Fiscal Responsibility and Budget Management Act (FRBMA) by the Centre which directs States to bring in discipline in the management of public finances has added pressure, particularly in improving productive assets of the poorer States. The fiscal discipline, though necessary, has resulted in decline in the share of capital expenditures in most of the states, particularly backward states. As States are depending more and more on market borrowing on the face of declining central loans to states that has led to reductions of the tenure but increased the cost

  • The FCs’ schemes of fiscal transfers over the years, held to serve the dual objectives of equity and efficiency within the framework of fiscal consolidation, have been unable to ensure a fair distribution of resources between Centre and States and among the States leading to increasing regional disparities. This regional disparity has been the basis of formulating the horizontal devolution (across states). Given the varying taxable capacity across states and high revenue expenditure (almost 80% of total expenditure) with rigid components like subsidies, pensions, salaries, wages, interest payments, to distribute exclusively to the net deficit states even after devolution of taxes and grants-in aid which is an encouraging step, particularly for backward states.
  • Generally, population and geography are considered as the most important criteria for tax devolution as it is perceived to be the most important indicator of the general need of a state. This approach is justified when there are very insignificant differences in area, distribution of population and per capita income among states. But, there are significant differences in these indicators among the States in India. Keeping this problem in view, more weightage has been given to distance and inverse formula in last few UFCs but population has been used as the scale factor. This high weightage given to population may not result in more transfers to states which are underdeveloped and having low population. The central plan assistance is being given on the basis of Gadgil formula (changes have been made since nineties), which takes population, per capita income, tax efforts and special problems into account. The criteria such as fiscal performance, tax efforts, prudent fiscal management, and elimination of illiteracy and successful implementation of land reforms etc over the time have not helped states with differential fiscal and administrative capabilities. 
  • All UFCs have indicated several shortcomings and omission and commission of the SFCs. The main reasons are non-synchronization of the period of recommendation of SFCs and UFCs; lack of clarity in respect of the assignment of powers, authority and responsibilities of the local government; absence of time limit to take appropriate action; etc. The 14th FC has made a significant change in the devolution of resources to the third tier by assigning a share of the divisible tax revenue
  • At the same time, as more and more of the states’ expenditure of the rural/urban local government is met by transfers from central government the autonomy of the states diminish likewise showing clear signs of the dependency syndrome.

Regional Disparity

  • There is wide variance in the provision of basic services like education, medical and other infrastructural facilities leading to discrepancies in major socioeconomic indicators like literacy rate, infant mortality rate, poverty ratio, and life expectancy etc. For example the highest IMR (per 1000 births) can be seen in lower income states such as Madhya Pradesh (2016) 47, Odisha (44), UP (43), Assam (44), Rajasthan (41) respectively where as it is much better in middle income and higher income states. 
  • Similar is the case of life expectancy and maternal mortality rate. A few states were able to attract investment (both domestic and foreign) and do better due to market reforms as well as their fiscal abilities to provide incentives and other utilities during post reforms period. Moreover, substantial changes in sectoral origin of income without appropriate re-distribution of population has created inequality both across the states and also within the states.
  • Therefore the role of central transfers to states is very important for ensuring provision of public services at a similar rate of taxation. It seems that the central transfers or center-states financial relations has not been very successful in fulfilling the main objective .i.e. to ensure equal provision of public services across sub-national government by reducing fiscal imbalances.


Overall, though efforts have been made towards a full-fledged federation, India continues to have greater vertical fiscal imbalances at different levels of governments and horizontal fiscal imbalance across the levels of governments. India has evolved a noble kind of federation which is completely different from the accepted notion of federation. The evolved Indian federalism is very unique in character and the Union-state relationship has also become extremely complex over the years. The rising inequality in an increasingly market economy demands scientific approach for fiscal transfers from Centre to states so that the objectives of fiscal federalism of equality and the provision of providing public goods across states is ensured.

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