Key Terms & Concepts — UPSC Mains
Fiscal Federalism
"The financial dimension of federalism — how taxing powers, spending responsibilities, and transfers are divided between the Union and states"
Fiscal federalism refers to the constitutional and institutional framework through which financial resources are distributed between the Union government and state governments in a federal system. It covers three core questions: who collects which taxes (revenue assignment), who spends on which services (expenditure assignment), and how the resulting vertical and horizontal imbalances are corrected through transfers (grants and devolution). In India, the Finance Commission (Article 280) is the primary institutional mechanism for achieving fiscal balance between the Centre and states.
India's fiscal federal structure is heavily tested in GS-2 (Centre-State relations) and GS-3 (economy). The vertical imbalance (states collect less than they spend) and horizontal imbalance (states have unequal revenue capacity) are the two core problems fiscal federalism tries to solve. GST, Finance Commission recommendations, and CSS architecture are all fiscal federalism issues.
- 1 Vertical imbalance — states receive more from the Centre than they collect themselves; Finance Commission devolution corrects this
- 2 Horizontal imbalance — richer states (Maharashtra, Karnataka) vs. poorer states (Bihar, UP) require redistribution via income-distance criterion
- 3 Finance Commission (Art. 280) recommends devolution; constituted every 5 years
- 4 Cess and surcharge are NOT shared with states — a growing fiscal grievance (from ~3% to ~20% of gross tax revenue)
- 5 73rd/74th Amendments created third tier of governance — but fiscal devolution to local bodies remains inadequate
- 6 GST Council is example of cooperative fiscal federalism — joint decision-making on indirect taxes
- 7 Grants-in-Aid (Art. 275 and 282) — tied and untied transfers for specific purposes
The 15th Finance Commission's recommendation of 41% vertical devolution (reduced from 14th FC's 42%) was a fiscal federalism decision — the 1% reduction reflected J&K/Ladakh's conversion to UTs, which now receive separate Union allocations.