Centre-State Financial Relations
Centre-State financial relations are a key part of India’s federal system. They are governed primarily by Part XII (Articles 268-293) of the Constitution. They determine how financial powers and resources are shared between the Union and State governments. This topic is very important for UPSC aspirants because it is frequently asked in both prelims and mains. Understanding it is essential to grasp how the Centre and States work together and manage financial responsibilities effectively.
These notes are prepared using the renowned Indian Polity book by M. Laxmikant, which is widely regarded as the best resource for this subject. The book simplifies complex ideas, and these notes further aim to present the topic in clear and easy-to-understand language while covering all critical aspects for the exam.
The topic of Centre-State financial relations is significant because it impacts governance, development, and the overall functioning of the country’s federal structure. The following key areas will be discussed, providing you with the best notes:
1. Allocation of Taxing Powers
2. Distribution of Tax Revenues
3. Distribution of Non-tax Revenues
4. Grants-in-Aid to the States
5. Goods and Services Tax (GST) Council
7. Protection of the States’ Interest
8. Borrowing by the Centre and the States
Allocation of Taxing Powers
(Centre-State Financial Relations) The Constitution divides the taxing powers between the Centre and the states, assigning specific subjects to each and regulating how taxes are levied and collected. The key aspects are as follows:
• Union List Taxes (Article 268-271):
• The Parliament has the exclusive power to levy taxes on the subjects enumerated in the Union List. These include taxes like income tax, customs duties, excise duties, corporation tax, etc. The Union List contains 13 specific items related to taxation.
• State List Taxes (Article 268A):
• The State Legislature has the exclusive power to levy taxes on the subjects in the State List. This includes taxes like sales tax, state excise duties, property tax, etc. The State List contains 18 items related to taxation.
• Concurrent List:
• There are no tax entries in the Concurrent List, which means both the Centre and the states cannot legislate on taxation matters concerning this list. However, the 101st Constitutional Amendment Act of 2016 created a special provision for the Goods and Services Tax (GST), enabling both the Centre and the States to concurrently legislate on this matter.
• Residuary Power of Taxation:
• The Parliament is vested with the residuary power of taxation, which means the Centre has the authority to impose taxes on subjects not specifically mentioned in the Union or State Lists. This power has been used for taxes such as gift tax, wealth tax, and expenditure tax.
2. Tax Collection and Distribution
• The power to levy and collect taxes is distinct from the power to appropriate the proceeds of taxes. For example, income tax is collected by the Centre but is then distributed between the Centre and the states as per a formula prescribed by the Finance Commission.
• The Centre and states share the proceeds of taxes through a system of devolution (the allocation of tax revenues between the Centre and the states). The distribution of proceeds is done in a manner to ensure fiscal cooperation and maintain federal equilibrium.
3. Restrictions on State Taxing Powers
While states have significant powers to levy taxes, the Constitution places several restrictions on them to maintain uniformity and avoid conflicts between state and national interests:
1. Taxes on Professions, Trades, and Employments:
• A state legislature can impose taxes on professions, trades, callings, and employments, but the total amount of tax payable by an individual cannot exceed ₹2,500 per annum.
2. Prohibition of Tax on Supply of Goods and Services:
• A state legislature is prohibited from imposing a tax on the supply of goods or services in two situations:
• Out-of-state supply: Where the supply occurs outside the state.
• Imports and Exports: Where the supply happens in the course of import or export.
• However, the Parliament is empowered to lay down the principles for determining when a supply happens outside the state or in the course of import/export.
3. Taxes on Electricity:
• States may levy taxes on the consumption or sale of electricity. However, the following exemptions apply:
• No tax can be imposed on electricity consumed by the Centre or sold to the Centre.
• No tax can be levied on electricity consumed for the construction, maintenance, or operation of railways by the Centre or railway companies.
4. Water and Electricity in Inter-State River Projects:
• States may levy taxes on water or electricity that is stored, generated, consumed, distributed, or sold by any authority that is established by Parliament for regulating or developing inter-state river systems.
• However, such laws must be reserved for the President’s assent, meaning they must be approved by the President before they become effective.
4. Goods and Services Tax (GST)
• GST is a key reform in the Indian taxation system, which was introduced via the 101st Constitutional Amendment. This amendment granted concurrent powers to both the Centre and states to legislate on the matter of GST. GST aims to unify the country’s tax structure, reduce cascading taxes, and facilitate interstate trade.
• The GST Council, which consists of representatives from both the Centre and the states, plays a significant role in harmonizing the rates and the framework for GST.
The Centre-State Financial Relations in India are designed to ensure fiscal cooperation while maintaining the autonomy of state legislatures. The division of taxing powers, the procedures for the collection and distribution of tax revenues, and the restrictions placed on state taxation powers are essential in ensuring a balanced federal financial system. The introduction of GST has further streamlined taxation between the Centre and states, fostering cooperation while maintaining the constitutional integrity of India’s federal structure. (Centre-State Financial Relations)
Distribution of Tax Revenues between the Centre and the States
The distribution of tax revenues between the Centre and the States is governed by various constitutional provisions, particularly under Articles 268 to 293 of the Constitution. Several amendments, such as the 80th Amendment (2000) and the 101st Amendment (2016), have introduced significant changes to this framework. Below is a detailed breakdown of the distribution of tax revenues as per the Constitution, particularly after the aforementioned amendments.
Key Provisions on Tax Distribution:
1. Taxes Levied by the Centre but Collected and Appropriated by States (Article 268):
• Stamp Duties: These include duties on bills of exchange, promissory notes, insurance policies, and transfer of shares. The proceeds of these taxes are assigned to the states where the tax is levied, rather than going into the Consolidated Fund of India.
2. Taxes Levied and Collected by the Centre but Assigned to States (Article 269):
• Inter-State Sale or Purchase Taxes: This includes taxes on the sale or purchase of goods (except newspapers) in the course of inter-state trade or commerce.
• Taxes on Consignment of Goods: Taxes on goods consigned in the course of inter-state trade are also assigned to the states as per the principles laid down by Parliament.
3. Levy and Collection of GST on Inter-State Trade (Article 269-A):
• The Goods and Services Tax (GST) on inter-state trade is levied and collected by the Centre but shared between the Centre and the States according to the recommendations of the GST Council. The Parliament is empowered to decide the principles for determining the place of supply.
4. Taxes Levied and Collected by the Centre but Distributed Between Centre and States (Article 270):
• This category includes taxes and duties listed in the Union List, except for those in Articles 268, 269, and 269-A. The distribution of the net proceeds of these taxes is decided by the President, based on the recommendations of the Finance Commission.
5. Surcharge on Taxes for the Centre’s Purposes (Article 271):
• The Centre can levy surcharges on taxes and duties mentioned in Articles 269 and 270. These surcharges are retained entirely by the Centre, and states do not share in these revenues. However, this surcharge cannot be levied on GST.
6. Taxes Levied and Collected and Retained by States (State List Taxes):
• These taxes are exclusively under the jurisdiction of the state legislatures and are not shared with the Centre. They are enumerated in the State List and include taxes such as:
1. Land Revenue and taxes on agricultural income.
2. Excise Duties on alcoholic liquors for human consumption.
3. Taxes on Sale of Electricity (but excluding those consumed by the Centre or its agencies).
4. Vehicle Taxes, tolls, and taxes on professions, trades, callings, and employments.
5. Stamp Duty on documents not specified in the Union List.
Impact of the 80th and 101st Amendments:
1. 80th Amendment (2000):
• Implemented the Finance Commission’s recommendations, which stipulated that 29% of the total revenue from central taxes (such as Corporation Tax and Customs Duties) should be shared with the states. This brought several central taxes under a shared arrangement with states, notably including Income Tax.
2. 101st Amendment (2016):
• Introduced the Goods and Services Tax (GST), replacing numerous indirect taxes at both the Union and State levels. The GST system aims to eliminate the cascading effect of taxes and provide for a common national market.
• This amendment gave both Parliament and State Legislatures the power to levy GST on goods and services transactions, which was a departure from the earlier system where taxes were largely assigned or collected by either the Centre or the States individually.
The constitutional framework for the allocation of tax revenues ensures a balanced distribution between the Centre and the States, taking into account the principle of cooperative federalism. Through various amendments, especially the 80th and 101st Amendments, India has streamlined its tax system, reducing fiscal distortion and promoting a more efficient and equitable tax structure. These provisions are designed to ensure a fair share of resources for both levels of government, enabling effective public service delivery and balanced economic growth across the nation. (Centre-State Financial Relations)
The Distribution of Non-tax Revenues
The distribution of non tax revenues between the Centre and the States is based on their respective sources of income, which are derived from different sectors and activities. Here is an overview:
A. Non-Tax Revenues of the Centre
The major sources of non-tax revenues for the Centre include:
1. Posts and Telegraphs: The Centre earns revenue from postal services and telecommunication services, including charges for mailing, telecommunication services, and other postal-related activities.
2. Railways: Revenue from passenger fares, freight charges, and other related services like station rentals and goods transport operations.
3. Banking: Revenue from interest on loans and advances, fees, and charges from banking services provided by government-owned financial institutions like the Reserve Bank of India.
4. Broadcasting: The Centre generates revenue from broadcasting services through licenses, advertisements, and other broadcasting-related activities.
5. Coinage and Currency: Earnings from the minting of coins and the printing of currency notes, which includes seigniorage income (profit made by the government by issuing currency).
6. Central Public Sector Enterprises (CPSEs): Revenue from dividends, profits, and disinvestment proceeds of public sector enterprises owned by the Centre.
7. Escheat and Lapse: Revenue from the property that escheats to the government (when no legal heir exists) or from property that lapses (e.g., unclaimed funds or assets).
8. Others: Other sources may include fines, fees, and other receipts that do not fall under taxes.
B. Non-Tax Revenues of the States
The major sources of non-tax revenues for the States include:
1. Irrigation: States collect revenue from the use of irrigation systems and water resources, including water rates and charges for the use of water for agriculture and other purposes.
2. Forests: Revenue from forest-related activities such as timber, fuelwood, and non-timber forest products, as well as various forest-based services.
3. Fisheries: Revenue generated from fisheries and aquatic resources, including licenses, levies, and fees for fishing rights and activities.
4. State Public Sector Enterprises (SPSEs): Revenue from dividends, profits, and other receipts from state-owned enterprises.
5. Escheat and Lapse: Similar to the Centre, states also receive revenue from property that escheats to the state government due to the lack of legal heirs or from lapsed assets.
6. Others: Other sources of non-tax revenues may include fees for services provided by the state government, such as registration fees, court fees, licenses, and other administrative charges.
In essence, while both the Centre and the States derive revenue from a mix of public sector enterprises, resources, and service-related activities, the Centre’s non-tax revenue sources tend to be more diversified and often tied to national-level services, such as railways, broadcasting, and coinage. States, on the other hand, primarily rely on revenues from local resources, including forests, irrigation, and fisheries. (Centre-State Financial Relations)
Grants-in-Aid to States
In addition to the sharing of taxes between the Centre and the States, the Constitution of India also provides for Grants-in-Aid from the Centre to support the financial needs of the states. These grants are designed to promote balanced development across the country, particularly for states that require additional financial assistance. The Constitution provides for three main types of grants: Statutory Grants, Discretionary Grants, and Other Grants.
1. Statutory Grants (Article 275)
Article 275 of the Indian Constitution empowers Parliament to make grants to states that are in need of financial assistance. These grants are not available to all states but are given based on the specific financial needs of a state.
• Criteria for Assistance: Statutory grants are provided to states that are financially weaker and in need of assistance for development. The Constitution does not mandate that all states must receive grants, and the amount given can vary depending on the economic needs of each state.
• Types of Statutory Grants:
• General Grants: These are provided to states in need of financial assistance for general purposes.
• Specific Grants for Scheduled Tribes and Areas: The Constitution also provides for grants specifically for the welfare of scheduled tribes or for improving the administration in scheduled areas (including states like Assam).
• Charged on the Consolidated Fund of India: These grants are charged on the Consolidated Fund of India, meaning they are guaranteed payments and do not require separate approval by the Parliament each year.
• Recommendation by the Finance Commission: Both general and specific grants under Article 275 are given based on the recommendations of the Finance Commission, which assesses the financial needs of the states.
2. Discretionary Grants (Article 282)
Article 282 of the Constitution allows both the Centre and the states to make grants for any public purpose, even if it falls outside their respective legislative competence. These grants are known as discretionary grants because the Centre is not under any constitutional obligation to give them; it is entirely at the Centre’s discretion.
• Purpose of Discretionary Grants:
• Financial Assistance for Plan Targets: Discretionary grants are often used to help states meet their financial targets under national or state plans.
• Central Influence: These grants also allow the Centre to exert influence over state actions and policies, ensuring coordination to meet the objectives of the national plan.
• Flexibility: These grants provide the Centre with flexibility to allocate funds based on specific needs and strategic objectives without being mandated by the Constitution.
3. Other Grants (Temporary Grants)
In addition to statutory and discretionary grants, the Constitution also provides for a third category of grants. These are temporary grants meant for specific purposes and are time-bound.
• Grants in Lieu of Export Duties on Jute: One such provision under Article 275 provided for grants in lieu of export duties on jute and jute products. These grants were to be given to the states of Assam, Bihar, Orissa, and West Bengal for a period of ten years from the commencement of the Constitution.
• Recommendation by the Finance Commission: Like other grants, these sums were charged on the Consolidated Fund of India and were given to the states based on the recommendation of the Finance Commission.
The Grants-in-Aid mechanism under the Constitution of India is designed to ensure that states facing financial constraints or specific development challenges are supported by the Centre. These grants are crucial for the financial health of states and to achieve equitable development across the country. The three types of grants—statutory grants, discretionary grants, and other temporary grants—serve different purposes and offer a combination of financial assistance and policy coordination between the Centre and the States.
Goods and Services Tax (GST) Council
The Goods and Services Tax (GST) Council was established to ensure the smooth and efficient administration of GST in India. The 101st Amendment Act of 2016 provided for the creation of the GST Council, and Article 279-A of the Constitution empowered the President to constitute the GST Council by an order.
The primary objective of the GST Council is to facilitate co-operation and co-ordination between the Centre and the States in implementing the GST system. It acts as a joint forum for both the Centre and the States, playing a crucial role in the decision-making process regarding GST-related matters.
Functions of the GST Council
The GST Council is responsible for making recommendations to the Centre and the States on the following matters:
1. Taxes, Cesses, and Surcharges:
• It recommends which taxes, cesses, and surcharges levied by the Centre, the States, and local bodies should be merged into GST.
2. Goods and Services to be Covered:
• It recommends the goods and services that may either be subject to GST or exempted from GST.
3. Model GST Laws and Principles:
• The Council suggests the Model GST Laws and the principles of levy.
• It also recommends the apportionment of GST collected on inter-state trade or commerce and establishes the principles that govern the place of supply.
4. Threshold Limit for Exemption:
• It recommends the threshold limit of turnover below which goods and services may be exempted from GST.
5. GST Rates:
• The Council is responsible for deciding the rates of GST, including floor rates with bands of GST to ensure uniformity in the tax structure.
6. Special Rate during Calamities:
• The GST Council may recommend a special rate or rates for a specified period to raise additional resources in the event of a natural calamity or disaster.
Composition of the GST Council
The GST Council consists of the following members:
• Union Finance Minister (Chairperson)
• State Finance Ministers from each State
• Union Minister of State for Finance (if applicable)
The GST Council is a critical body for the implementation and administration of the Goods and Services Tax in India. Its function as a joint forum for the Centre and the States ensures that the taxation system remains uniform and coordinated across the country. The Council’s recommendations on tax structure, rates, and exemptions play a key role in the economic planning and fiscal health of both the Centre and the States. (Centre-State Financial Relations)
Finance Commission (Article 280)
The Finance Commission is a quasi-judicial body established under Article 280 of the Indian Constitution. It is constituted by the President every fifth year or earlier, as required, to make recommendations on fiscal matters to ensure a balanced and equitable distribution of financial resources between the Centre and the States.
The Finance Commission plays a critical role in maintaining fiscal federalism in India and ensures that the financial relationship between the Centre and the States remains fair and efficient.
Functions of the Finance Commission
The Finance Commission is required to make recommendations to the President on the following matters:
1. Distribution of Tax Proceeds:
• The Finance Commission recommends the distribution of the net proceeds of taxes to be shared between the Centre and the States. It also allocates the respective shares of such proceeds between the States.
2. Grants-in-Aid:
• It recommends the principles that should govern the grants-in-aid from the Centre to the States, which are charged on the Consolidated Fund of India.
3. Augmenting State Resources:
• The Commission suggests the measures needed to augment the Consolidated Fund of a State. This is to supplement the resources of Panchayats and Municipalities in the state, based on the recommendations made by the State Finance Commission.
4. Any Other Matter:
• The Finance Commission may be referred any other matter by the President, which is important for maintaining sound finance in the country.
Historical Function (Till 1960)
Up until 1960, the Finance Commission also provided recommendations regarding the amounts to be paid to the States of Assam, Bihar, Orissa, and West Bengal. These payments were made in lieu of assignment of any share of the net proceeds of export duties on jute and jute products.
Role of Finance Commission in Fiscal Federalism
The Finance Commission is considered the balancing wheel of fiscal federalism in India. It ensures that financial resources are allocated in a manner that supports the development of both the Centre and the States while promoting equity and uniformity in resource distribution. This is critical for maintaining a harmonious relationship between the Centre and the States, helping address regional disparities and enabling the effective implementation of policies and programs across the country.
In essence, the Finance Commission plays a key role in the financial governance of India, fostering fiscal stability, ensuring fair resource distribution, and supporting the growth of both central and state governments in a balanced manner. Its periodic recommendations are vital for strengthening fiscal federalism in India. (Centre-State Financial Relations)
Protection of the States’ Interest
The Indian Constitution includes specific provisions to protect the financial interests of the States in relation to the Centre. These protections ensure that any legislation affecting the financial rights or interests of the States can only be introduced in Parliament after receiving the recommendation of the President. This safeguard is particularly important for maintaining the balance of power and fiscal autonomy between the Centre and the States.
Bills Requiring Presidential Recommendation
The Constitution mandates that the following types of bills can only be introduced in Parliament after the recommendation of the President:
1. Bills Imposing or Varying Taxes or Duties in Which States Are Interested:
• Any bill that imposes or varies a tax or duty in which States have a financial stake can only be introduced with the President’s recommendation. This ensures that States’ interests are considered when tax policies are formulated or altered.
2. Bills Affecting the Definition of ‘Agricultural Income’:
• Any bill that alters the definition of ‘agricultural income’ for the purposes of income tax law requires the President’s recommendation. Agricultural income is a crucial aspect of the fiscal relationship between the Centre and States, especially since States have a vested interest in defining this term for taxation purposes.
3. Bills Affecting the Distribution of Money to States:
• Any bill that affects the principles on which moneys are distributable to the States requires Presidential approval. This ensures that States’ financial allocations are safeguarded.
4. Bills Imposing a Surcharge for the Centre:
• Any bill that imposes a surcharge on a specified tax or duty for the Centre also requires Presidential recommendation. This provision ensures that the Centre cannot unilaterally increase its share of taxes without considering the impact on the States.
Definition of “Tax or Duty in Which States Are Interested”
The term “tax or duty in which states are interested” is crucial for understanding the scope of this protection. It refers to:
1. Taxes or Duties Whose Proceeds Are Assigned to States:
• This includes taxes or duties where the whole or part of the net proceeds are assigned to any State. For example, a tax whose revenue is shared between the Centre and a specific State would fall under this category.
2. Taxes or Duties Linked to Payments from the Centre to States:
• This refers to taxes or duties from which sums are payable out of the Consolidated Fund of India to the States. If a tax affects the flow of funds from the Centre to the States, it is considered a matter in which the States have a financial interest.
Net Proceeds and the Role of the Comptroller and Auditor-General
The ‘net proceeds’ of a tax or duty are defined as the total proceeds of that tax or duty minus the cost of collection. This ensures that the States’ share is based on the actual revenue generated, after accounting for the administrative expenses incurred by the Centre.
• The Comptroller and Auditor-General of India (CAG) plays a key role in determining the net proceeds of a tax or duty in any area. The CAG’s certification of these net proceeds is considered final. This means that the determination of the net proceeds, as calculated by the CAG, cannot be contested, providing transparency and certainty in the fiscal relationship between the Centre and States.
These constitutional provisions help in protecting the financial interests of States, ensuring that their rights are respected in matters related to taxes, duties, and financial distributions. By requiring the President’s recommendation for the introduction of such bills, the Constitution ensures that States have a say in policies that impact their fiscal autonomy and resource allocation. This balance of power is vital for maintaining the federal structure of India.(Centre-State Financial Relations)
Borrowing by the Centre and the States
The Constitution of India outlines specific provisions regarding the borrowing powers of the Centre and the States, ensuring a clear framework for managing public debt and maintaining fiscal discipline. These provisions prevent unchecked borrowing and safeguard the financial interests of both levels of government.
1. Borrowing Powers of the Centre
• The Central government can borrow both within India and abroad. Borrowing is allowed upon the security of the Consolidated Fund of India, which is the primary source of revenue for the Centre.
• The limit on borrowing by the Centre is to be fixed by Parliament. However, it is important to note that no such specific law has yet been enacted by Parliament, meaning the borrowing limits are currently undefined by legislation. The Monetary Policy and fiscal guidelines from institutions like the Reserve Bank of India (RBI) and Finance Commission often guide borrowing practices.
2. Borrowing Powers of the States
• A state government can borrow only within India and not abroad. The state government can borrow funds upon the security of the Consolidated Fund of the State.
• Like the Centre, the state legislature fixes the limits within which the state can borrow. This ensures that states cannot engage in excessive borrowing beyond their capacity, thus maintaining fiscal responsibility.
3. Loans and Guarantees from the Centre to States
• The Central government can lend money to states or provide guarantees for loans raised by states. This is an important mechanism through which the Centre can assist financially distressed states.
• Any sums required for making such loans or guarantees are to be charged on the Consolidated Fund of India. This means that the amount spent by the Centre on these loans or guarantees will come directly from the Centre’s financial resources.
4. Borrowing by States with the Centre’s Consent
• States cannot raise loans without the consent of the Centre if any outstanding loans remain from previous loans made by the Centre to the state or if the Centre has provided any guarantee for a state’s loan.
• This provision ensures that the Centre maintains control over the borrowing activities of states when there is an outstanding obligation or guarantee, preventing excessive debt accumulation that could negatively impact national fiscal health.
The borrowing powers of the Centre and the states are tightly regulated by the Constitution of India, with safeguards in place to maintain fiscal discipline. The Centre has broader borrowing powers, including the ability to borrow from abroad, but the states’ borrowing is more restricted, focusing on internal borrowing only. Both levels of government are subject to limits and oversight, with the Centre holding significant control over the borrowing decisions of the states, particularly when there are outstanding loans or guarantees. This arrangement helps to ensure that borrowing does not become an avenue for irresponsible debt accumulation, safeguarding the overall financial stability of the nation. (Centre-State Financial Relations)
Inter-Governmental Tax Immunities in India
The Indian Constitution, like other federal systems, incorporates the principle of “immunity from mutual taxation”, meaning that the Centre and the States cannot tax each other’s property and income in certain cases. This principle is crucial in maintaining a balance of power and ensuring that the financial autonomy of each level of government is respected. Below are the key provisions related to tax immunities between the Centre and the States.
1. Exemption of Central Property from State Taxation
• Central Government Property: The property of the Central government is exempted from all taxes imposed by state governments or any authority within a state, such as municipalities, district boards, and panchayats. This ensures that the Centre’s property is not subject to state-level taxation.
• Scope of ‘Property’: The term ‘property’ includes a wide range of assets: lands, buildings, chattels, shares, debts, and any tangible or intangible property that holds monetary value. Both sovereign (e.g., armed forces) and commercial uses of this property are covered under this immunity.
• Parliamentary Authority: The Parliament has the power to remove this immunity if it so chooses, meaning that the Parliament can allow the states to tax Central property under specific circumstances.
• Corporations and Companies: Corporations or companies established by the Central government are not immune from state taxation or local taxation. This is because such entities are treated as separate legal entities, distinct from the government itself.
2. Exemption of State Property or Income from Central Taxation
• State Government Property and Income: The property and income of the State governments are exempt from Central taxation. This immunity applies regardless of whether the income is derived from sovereign (e.g., law enforcement) or commercial functions.
• Taxing State’s Commercial Operations: The Centre can tax the commercial operations of a state, provided that Parliament passes a law enabling such taxation. However, the Parliament can declare certain state activities as incidental to government functions, thus exempting them from Central taxation.
• Local Authorities and State-Owned Entities: Property and income of local authorities (such as municipalities or panchayats) situated within a state are not exempted from Central taxation. Similarly, the property or income of state-owned corporations or companies is subject to Central taxes.
3. Customs and Excise Duties
• The Supreme Court (1963), in its advisory opinion, clarified that the immunity granted to states regarding Central taxation does not extend to customs duties or excise duties.
• Customs Duty: The Centre can impose customs duties on goods that are imported or exported by a state, even though the goods belong to a state.
• Excise Duty: Similarly, the Centre can impose excise duties on goods produced or manufactured by a state. This ensures that the Centre retains the authority to tax goods at the national level, even when they are produced within a state’s jurisdiction.
The principle of Inter-Governmental Tax Immunities helps maintain a balance between the fiscal powers of the Centre and the States. While the property and income of the Centre and States are generally protected from taxation by the other level of government, there are exceptions and areas where one can tax the other, particularly in commercial activities or with specific provisions from Parliament. These immunities safeguard the financial autonomy of each level of government, ensuring that their core functions are not unduly hindered by the taxation powers of the other.(Centre-State Financial Relations)
Effects of Emergencies on Centre State Financial Relations
The financial relations between the Centre and the States in India undergo significant changes during emergencies. The Constitution allows for certain provisions that alter the normal distribution of financial powers when emergency situations arise. These provisions are detailed under National Emergency (Article 352) and Financial Emergency (Article 360), and they enable the Centre to exercise additional control over state finances.
1. National Emergency (Article 352)
When a National Emergency is declared, it leads to several changes in the financial relations between the Centre and the States:
• Modification of Revenue Distribution: The President, under Article 352, has the authority to modify the constitutional distribution of revenues between the Centre and the States. This means that the Centre can reduce or cancel the transfers of finances to the States, which include both tax-sharing and grants-in-aid.
• Duration of Modification: This modification in the distribution of revenues remains in effect until the end of the financial year in which the emergency period ends. Thus, the fiscal autonomy of the States can be significantly affected during the period of emergency.
• Impact on States: The reduction or suspension of financial transfers to the States can lead to financial difficulties, limiting their capacity to carry out developmental activities or even meet basic operational expenditures.
2. Financial Emergency (Article 360)
Under Article 360, if a Financial Emergency is declared, the Centre gains further powers to intervene in the financial affairs of the States:
• Canons of Financial Propriety: The Centre can direct the States to observe the specified canons of financial propriety, which include a range of fiscal discipline measures to ensure that states are managing their finances prudently.
• Reduction of Salaries and Allowances: The Centre can instruct the States to reduce the salaries and allowances of all classes of persons serving within the States, including government employees. This is a measure to control expenditure at the state level during financial distress.
• Reservation of Financial Bills: The Centre can reserve all money bills and financial bills introduced by the States for the President’s consideration. This gives the Centre additional control over the financial legislation passed by the States, ensuring that it aligns with national priorities.
During National Emergency and Financial Emergency, the Centre gains enhanced powers to control the financial relations between the Centre and the States. These provisions are designed to address situations where the financial stability of the country or a state is in jeopardy, enabling the Centre to make adjustments to ensure overall financial stability. However, such powers also diminish the fiscal autonomy of the States, which may experience financial constraints as a result of these emergency measures.(Centre-State Financial Relations)