Answer Synopsis 04/12/2020

Question :What are the constitutional provisions governing the financial relations between the Union and the States. Comment on the role of Finance Commission in this regard.

Structure of the answer

  • Write about the constitutional scheme governing financial relations between Union and states.
  • Discuss the role of Finance Commission in fiscal federalism.


The Financial relationship between the Union and the States is provided in Part-XII of the constitution.

Constitutional Scheme:

  1. The Parliament levies taxes on items mentioned in the union list while the state legislatures levy taxes on items mentioned in the state list.
  2. The residuary power of taxation belongs to the centre.
  3. Other categories of taxes.
    • Article 268: Taxes levied by the union government but collected and appropriated by the states. Stamp duties, etc fall in this category.
    • Article 268-A: It includes service tax, levied by the Union but collected and appropriated by the Union and the states.
    • Article 269: Duties levied and collected by the union but the net proceeds are distributed among the states. Tax on inter-state trade, succession duty, etc. fall in this category.
    • Article 270: Taxes levied and collected by the union but the proceeds are distributed between the centre and the states. Taxes incomes etc, fall in this category.

The manner of distribution of the net proceeds of these taxes is prescribed by the President on the recommendations of the Finance Commission.

  • Constitution also provides for grants-in-aid to states, under Article 275 (statutory grants) and Article 282 (discretionary grants). The former is based on the recommendation of Finance Commission.

Finance Commission

Finance Commission is the balancing wheel of fiscal federalism under Article 280. It is a quasi-judicial body, appointed after every five years, entrusted with the following functions:

  1. Recommending the distribution of net proceeds of taxes between Centre and the States.
  2. Suggesting the mechanism to share tax revenues, the Commission also lays down the principles for giving out grant-in-aid to states and other local bodies as follows
  3. Determine factors governing Grants-in Aid to the states and the magnitude of the same.

Limitations of Finance Commission

  1. Its recommendations are not binding on the Union.
  2. The major junks of grants are extended under Article 282, based on the recommendations of erstwhile Planning Commission due to political expediency.
  3. Its role is informally limited to only the capital expenditure requirements of the states.

The current scheme of division of financial resources is certainly very complicated, having the effect of making the states financially dependent on the centre. Therefore, violative of federalism.

Way Forward

The states should be given more fiscal autonomy to achieve their goals enshrined in the DPSP and state list of Constitution. The greater devolution of statutory grants under recommendation of 14th Finance Commission could provide them with greater resources and independence.

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