Fiscal federalism in India refers to the financial relations between the Centre and the States. The Constitution divides taxing powers and expenditure responsibilities among different levels of government. While this system aims to ensure balanced development and cooperative federalism, it faces several challenges. Differences in revenue capacity, expenditure needs, and regional inequalities create financial stress. One major issue is the imbalance between revenue powers and spending responsibilities. These challenges affect efficient governance, State autonomy, and overall economic development.
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Vertical Fiscal Imbalance
Vertical fiscal imbalance refers to the mismatch between the revenue powers and expenditure responsibilities of the Centre and the States. In India, the Centre has more taxation powers, while States have greater responsibility for public services like health, education, and agriculture. As a result, States depend heavily on central transfers and grants. This dependence reduces financial autonomy of States and affects their planning capacity. Though Finance Commission recommendations try to correct this imbalance, the problem continues. Vertical imbalance also leads to political bargaining and delays in fund release. It remains a major challenge in achieving true fiscal federalism.
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Horizontal Fiscal Imbalance
Horizontal fiscal imbalance arises due to differences in revenue capacity and development levels among States. Richer States can generate more revenue, while poorer States depend heavily on central assistance. This creates inequality in public service delivery across the country. The Finance Commission uses criteria like population, income distance, and area to reduce this imbalance. However, complete equality is difficult to achieve. Regional disparities continue due to historical and economic factors. Horizontal imbalance challenges the goal of balanced regional development and requires continuous policy support and fair resource distribution.
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Dependence on Central Transfers
Indian States rely heavily on central transfers such as tax devolution and grants. This dependence limits State financial independence and decision making. Delays or conditions attached to funds affect implementation of State policies. Centrally sponsored schemes often impose uniform priorities, ignoring local needs. States with weak revenue base face greater difficulty. Excessive dependence also reduces accountability and efficiency in public spending. Though transfers are necessary, over reliance weakens cooperative federalism. Strengthening State revenue capacity is essential to address this challenge.
- GST and Revenue Uncertainty
The introduction of Goods and Services Tax changed fiscal federalism in India. While GST aimed to create a unified market, it reduced States’ independent taxation powers. States now depend on GST compensation from the Centre. Delays and uncertainty in compensation have created financial stress. States face difficulty in managing budgets and funding welfare schemes. Disputes in the GST Council also highlight coordination challenges. Though GST promotes efficiency, it has added complexity to Centre State financial relations.
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Political and Administrative Challenges
Political differences between the Centre and States affect fiscal federalism. Allocation of funds may be influenced by political considerations. Administrative capacity of States also varies, affecting fund utilization. Weak monitoring and accountability lead to inefficient spending. Lack of coordination creates overlap and wastage. These challenges reduce the effectiveness of fiscal decentralization. Strengthening institutional mechanisms and transparency is necessary to improve fiscal federalism in India.