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Current Affairs


Date : Dec 23, 2021

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Based on a News Article published in the ‘The Hindu’ on 21th December 2021 on Page Number 7


Useful for UPSC CSE Prelims and Mains (GS Paper III)


  • The Finance Commission and the Niti Ayog (erstwhile Planning Commission) in India promote fiscal federalism by carrying out systemic fiscal transfers in the form of devolution or conditional transfers, but with the Planning Commission's replacement by the NITI Aayog, there is an urgent need to revisit and re-define India's fiscal architecture.


Fiscal Federalism in India:


  • The principles of fiscal federalism and income sharing between the Centre and the states were established by the Government of India Acts of 1919 and 1935.
  • Dr. Y V Reddy, the chair of the 14th Finance Commission, suggested a 42 percent revenue devolution to the states.
  • The Goods and Services Tax (GST) was implemented in 2017 to simplify India's indirect tax structure and foster cooperative federalism by giving states a greater role in creating and executing the revamped taxation system.
  • The NITI Aayog, which was founded in 2015, was supposed to address new macroeconomic realities that the Planning Commission had overlooked.


The requirement for India's Fiscal Federalism to be redefined:


  • Rising regional inequality and horizontal imbalances: By replacing the Planning Commission (which was mandated to give grants to states as conditional transfers using the Gadgil-Mukherjee formula) with NITI Aayog (a government think tank with no resources to disburse), the government's policy outreach has been reduced by relying solely on the Finance Commission, a single instrument of fiscal federalism. If not revised, this strategy could lead to a severe problem of growing regional and sub-regional imbalances.





Imbalances in the Horizontal Fiscal Federalism:


  • Horizontal imbalances arise as a result of states' various degrees of achievement as a result of distinct growth rates and developmental status in terms of social or infrastructure capital.
  • Horizontal imbalances can be divided into two categories:
  • Type I is concerned with the provision of adequate public goods and services.
  • Growth-accelerating infrastructure or transformational capital deficits cause Type II.


Imbalances in the Vertical Fiscal Federalism:


  • The fiscal asymmetry in taxation authorities vested in different levels of government in relation to their constitutionally mandated expenditure responsibilities causes vertical imbalance.
  • Vertical inequity: In India's fiscal federalism (three levels of government: Central Government, State Governments, and elected Local Bodies), the central government has a significantly broader range of taxation powers (e.g., personal and corporate income taxes, CGST, foreign transaction taxes, and so on).
  • The central government collects approximately 60% of total taxes, yet only 40% of total public expenditure is spent on constitutionally mandated functions such as defence.
  • The third tier, which consists of elected local bodies and panchayats, has even more vertical imbalances.
  • Vertical inequalities can wreak havoc on India's urbanisation and the quality of local public goods, exacerbating the negative externalities associated with climate change.


Fiscal Federalism Restructuring:


  • In order to overcome the shortcomings of vertical and horizontal inequalities, India's Fiscal Federalism must be reformed on four pillars: the Finance Commission, the NITI Aayog, GST, and decentralisation.
  • The Finance Commission must be relieved of the dual burden of providing fundamental public goods and services while also dealing with capital shortfalls. It should be limited to addressing the imbalance in basic public goods (Type I).
  • The NITI Aayog can act as a second pillar in the fight against infrastructure and capital shortfalls (Type II).
  • It should be involved in capital allocation in a different way than the Finance Commission, using distinct metrics for allocation.
  • Regional Inequities: NITI Aayog should be given significant funding (1 percent to 2% of GDP) to address regional and subregional disparities across states by eliminating development imbalances in sectors such as infrastructure deficits.
  • Independent Evaluation Office: The NITI Aayog should be mandated to establish an independent evaluation office to monitor and analyse the efficacy of income and capital grant usage.
  • Decision-Making Body: It should be an important part of the decision-making process since it can effectively negotiate resource transfers between states.
  • By boosting local finances and the state finance commission, decentralisation can serve as the third pillar of the new fiscal federalism.
  • Local public finance: the establishment of a consolidated fund for urban local bodies and Panchayati Raj institutions.
  • The Centre and States should each contribute an equal share of their Central GST (CGST) and State GST (SGST) collections to the third-tier consolidated fund.
  • The sharing of one-sixth of the CGST and SGST with the third tier can generate more than 1% of GDP annually for the financing of public goods by city-level organisations.
  • The 3Fs of democratic decentralisation (funds, functions, and functionaries) should be fully implemented, and state finance commissions should be given the same status as the Union Finance Commission.
  • The Goods and Services Tax (GST) should be simplified in structure and can serve as the fourth pillar of our fiscal federalism by ensuring: Single Rate GST: with appropriate surcharges on "sin goods" (goods that are harmful to society and individuals, such as alcohol and tobacco, drugs, and so on), zero-rating of exports, and reforming the Integrated Goods and Services Tax (IGST) and the e-way bill.
  • Transparency: By establishing its own secretariat and independent specialists, the GST Council should implement reforms in a well-informed and transparent manner (as its staff).


GST (Goods & Services Tax):


  • Every value addition is subject to GST, which is a multi-stage, destination-based tax.
  • GST is a single indirect tax that applies to the entire country.
  • The GST Council is the main decision-making body for the GST. It will make all major GST decisions.




  • The creation of a new fiscal federal architecture based on efficient decentralisation, a clear GST regime, an independent Finance Commission, and an effective NITI Aayog can help India's cooperative federalism to thrive.

Tags : GST regime, NITI Aayog

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