Kaustubh Balaji, third year B. Com. LL. B, School of Law SASTRA Deemed to be University, Thanjavur, Tamil Nadu, India.
Abstract:
The present research explores the constitutional elements of fiscal federalism with a particular emphasis on the implications of the Centre’s imposition of borrowing limitations on state governments’ financial management. This paper examines the convoluted interactions between the federal and state governments, as well as the legal and financial ramifications of these borrowing restraints. Through an analysis of the historical background and current issues, the study clarifies the changing dynamics of centre-state interactions within India’s federal framework.
The study’s methodology includes a comprehensive literature evaluation, inspection of prevailing frameworks, judicial precedents, and scholarly exchanges. It attempts to deliver nuanced viewpoints on the constitutional stresses inherent in fiscal federalism and workable solutions for improving financial governance through analysis and theoretical insights. In the end, this study aims to add to the current conversation in India about cooperative federalism and constitutional amendments by highlighting the necessity of striking a balance between state autonomy and budgetary restraint within the federal system.
Keywords: Centre, State, Fiscal Discipline, Federalism, Borrowing
Introduction:
A key component of modern governance is the idea of fiscal federalism, which defines how financial power is distributed between the national government and its subnational counterparts in a nation. Based on decentralization concept, it aims to safeguard national economic stability while streamlining resource allocation and decision-making procedures that are customized to regional requirements. The complex balance between state liberty and fiscal prudence is fundamental, and it is embodied in the way that state borrowing limitations
are managed. These limitations are significant tools in the field of fiscal federalism; they are essential for controlling subnational debt and reducing fiscal susceptibilities. Governments strive to ensure fiscal stability, prevent debt crises, and promote equitable financial management across generations by enforcing prudent borrowing boundaries.
The controversy over the Indian government’s decision to impose borrowing restrictions on state governments is the source of this study. Notably, Kerala has objected to these limitations, claiming that they violate its right to fiscal independence. Kerala contends that these restrictions make it harder to manage money wisely and have an impact on wage distributions. This disagreement highlights more general debates over state sovereignty and fiscal federalism in India.
Within the scope of Indian politics, this conceptual framework is embodied in the nation’s Constitutional model of centre-state financial relations. The financial interactions between the Union and the States are outlined in Articles 268 through 293. The Seventh Schedule divides up fiscal responsibilities. The Union is in charge of things like goods and services, income taxation, and land revenue, while the States are in charge of things like stamp duties and land revenue. But current patterns show a clear tendency in the direction of financial power centralization, as demonstrated by the Centre’s imposition of borrowing limitations on the States.
Though ostensibly motivated by budgetary prudence, these limitations have raised questions about how they would affect state autonomy and the core principles of fiscal federalism.
Limits on borrowing restrict state governments’ ability to manage their budgets, which may make it more difficult for them to meet localized requirements and regional financial objectives.
In light of this, this research paper attempts to explore the constitutional subtleties of India’s state borrowing caps in the context of fiscal federalism. In order to provide light on the changing dynamics of centre-state financial interactions, we examine historical antecedents, legal frameworks, and practical ramifications. Through a close examination of these factors, the article aims to clarify the complex consequences for fiscal governance under the federal system of India. By means of a sophisticated examination, our aim is to furnish discernments that not only clarify the intricacies of the topic but also furnish a thorough comprehension of
the obstacles and prospects that are present in the interaction between central and state financial authorities.
Research Methodology:
The qualitative research methodology utilized in this study emphasizes an exhaustive examination of established literature, scholarly dialogues, legal structures, and precedents. It entails a thorough review and amalgamation of pertinent literature, encompassing academic articles, legal texts, and policy documents
Data collection
The main method of gathering data is to do a thorough literature study using credible government, academic, and legal databases. A thorough grasp of the legal frameworks and precedents relevant to the study issue is also provided by a close examination of important legislation, case laws, and constitutional provisions.
Data Analysis
The gathered information is subjected to a thorough thematic analysis in order to pinpoint important themes, patterns, and trends in the literature. Insightful legal rulings, court rulings, and legislative actions pertaining to state borrowing caps, fiscal federalism, and centre-state financial ties are all given particular consideration.
Interpretation and Synthesis
A logical narrative that meets the study goals is developed by interpreting and synthesizing the results of the legal analysis and literature assessment. This entails assessing the points made in the literature critically and placing them in the perspective of India’s larger legal and budgetary environment.
Limitations Of the Study:
Although this methodology offers insightful information on the study issue, it is important to recognize its possible drawbacks. These include the accessibility and availability of pertinent material, the differences in how the law is interpreted in different jurisdictions, and the prejudices that are present in the sources that were chosen.
Literature Review:
The concept of federalism denotes a political framework wherein authority is dispersed between a central entity and constituent political entities, such as states or provinces, each endowed with its own domain of jurisdiction. The historical antecedents of federalism can be discerned in ancient civilizations, including Greek city-states, the Roman Republic, and diverse medieval European arrangements. The modern articulation of federalism took shape during the Enlightenment epoch, notably epitomized by the crafting of the United States Constitution in 1787(Mark J. Rozell & Clyde Wilcox), which served as a template for numerous subsequent federative structures.1
India’s federalist paradigm has deep-seated historical underpinnings, dating back to the era of British colonialism, during which elements of federal governance were discernible, albeit under a distinct guise (B.R Amedhkar). 2The enactment of the Government of India Act in 1935 laid the groundwork for India’s federal configuration, a blueprint subsequently enshrined in the Constitution of India upon its adoption in 1950. The essence of India’s federalism lies in its distinctive amalgam of robust central authority and significant autonomy delegated to the constituent states, mirroring the multifarious socio-cultural and political tapestry of the nation (Article 1).3
The dynamics of Indian federalism have been the focal point of scholarly inquiry, with investigations spanning a gamut of issues encompassing intergovernmental relations, fiscal sovereignty, and the sway of regional political entities.
While fiscal federalism refers to how various levels of government, such as the federal and state governments, divide up money and financial duties. It involves allocating funds for certain purposes and designating the tax collectors. For instance, in a nation with fiscal federalism, the federal government would be in charge of major matters like national security, while the state governments would be in charge of items like healthcare and education. Effective utilization of resources and a balance of power between the various governmental levels are two benefits of fiscal federalism.
1 Mark J. Rozell & Clyde Wilcox, Federalism: A Very Short Introduction (2019) https://www.google.co.in/books/edition/Federalism_A_Very_Short_Introduction/pSa3DwAAQBAJ?hl=en&gbpv=0
2 B.R. Ambedkar, The Evolution of Provincial Finance in British India, 165 (King, 1925). https://www.shrigururavidasji.com/site/articles_books/files/ambedkar/40_the-evolution-of-provincial-finance-in-british-india.pdf
3 Indian Constitution art. 1.
In reality, India’s fiscal federalism may be seen as a political, economic, and public finance game between the Union and the States (Rao, M.G)4. It may also be seen as the interaction of institutions, people, institutions, goals, and ideologies or beliefs. We might be able to understand the current state and potential future of fiscal federalism in the nation by looking into these fundamental causes.
The Union and the States each have different roles and obligations under the federal system. Although the term “Centre” is not used in the Constitution, the terms “Union” and “Centre” are frequently used synonymously in Indian fiscal federalism literature. Additionally, the two share responsibility for spending and tax collection (Article 268)5.
A separation of this kind leaves the Centre and the States with unequal revenue and spending obligations. The States have more duties, particularly in the areas of economic and social services, even if the Centre receives a bigger portion of the cash (Louise Tillin)6. This is the cause of the vertical imbalance in fiscal management, which has to be corrected by fiscal transfers or tax sharing (Reddy, Y.V. and Reddy, G.R., )7.
While the States bear the brunt of approximately 60% of all government spending (that is, spending from both the Centre and the States combined), they only get roughly 40% of the total revenue. Additionally, borrowing is used to pay for State or Central government expenses. Nevertheless, when a State borrows money, the Union Government must approve it because the State is in debt to the latter (PRS 2023)8. To put it mildly, this is a Union against States game.
States differ greatly in the disparities between their ability to collect money and their demands for expenditure. These disparities are attempted to be addressed via the revenue sharing and transfer procedures. As a result, payments to States with lower per capita incomes are larger. Transfers, however, do not entirely make up for the poorer States’ revenue limitations. Richer States may spend much more per person than less wealthy ones, but they
4 M.G. Rao, A Review of Indian Fiscal Federalism, Report of the Commission on Centre-State Relations, Research Studies, 1 (2010) https://interstatecouncil.gov.in/wpcontent/uploads/2015/06/Suppl_VolII_Research_Studies.pdf.
5 Indian Constitution art. 268.
6 Louise Tillin, Does India Have Subnational Welfare Regimes? The Role of State Governments in Shaping Social Policy, 10 Territory, Politics, Governance 86–102 (2021)
7Y.V. Reddy & G.R. Reddy, Indian Fiscal Federalism (Oxford Univ. Press, 2018). https://www.google.co.in/books/edition/Indian_Fiscal_Federalism/jvqNDwAAQBAJ?hl=en&gbpv=1&dq=Y.V.+Reddy+%26+G.R.+Reddy,+Indian+Fiscal+Federalism+(Oxford+Univ.+Press,+2018&pg=PT7&printsec=frontcover
8 PRS, Finances of the Central Government (2023). https://prsindia.org/files/budget/Finances-Central_Government.pdf
believe they should be given more resources to do better. The States vie with one another for a larger portion of the Centre’s total fund corpus. As a result, we have a situation that may be characterized as the Union versus the contending States of India a game in which the States compete against each other and the Centre.
Differences in gross state domestic product (GSDP) per capita income between states are unavoidable. State-level changes in per capita GSDP are closely correlated with state-level revenues per capita. disparities in revenue capacity are the primary source of the disparities in per capita revenues and per capita incomes. At the same time, it is expected that every resident of a nation should have access to a minimal quality of life that is acceptable across the nation, or at the at least, to a certain level of governmental services including security, street lights, roads, and health and education options.
Inequalities exist in both vertical and horizontal aspects of public debt accessibility. The macroeconomic environment determines the overall borrowing restrictions. Constitutional provisions and the opinions of the financial market provide the Union Government preferential access to debt finance. The poorer States believe that current fiscal federal relations do not account for the disadvantages in their access to and cost of borrowing.
The way in which vertical and horizontal imbalances are managed has changed throughout time, in part due to changes in the economy and in part to political economics factors.
To address these inequalities, the President of India is required by our Constitution to establish a Finance Commission once every five years. The Commission offers suggestions on revenue-aid grants and tax devolution. Both continuity and change have been seen in the Finance Commission’s goals and operations. Its operation has been essential from the beginning and will remain so (Article 280)9. In addition, the Indian government has been using its discretion to make transfers outside of the Finance Commission’s recommendations.
Another point of disagreement between the Union and the States has been the proportional proportions of transfers that are not Finance Commission and those that are. Implicit and hidden transfers exist in addition to explicit transfers to States via various pathways. The primary forms of these transfers include administered pricing, tax exportation, priority
9 Indian Constitution art. 280.
sector financing, tax exportation, central government investments in public businesses, and interest subventions.
These undetectable transfers are regressive, as demonstrated by a research (Rao 1997)10. Despite the fact that the amount of invisible transfers matters in fiscal federalism, this element is hardly examined due to the difficulties in determining their influence and volume.
General-purpose and specific-purpose transfers are the two types of transfers that the Central Government can make to the States. These might be optional or based on a formula. The mixture has been fluctuating, and neither a trend nor a clear cause can be identified for the mix’s changes.
While the States as a whole want more non-discretionary funding, they are hesitant to renounce their claims to discretionary grants. States are required to match a large portion of the Centre’s funding, and they would prefer to contribute as little as possible.
Factors that primarily interplay in fiscal federalism are that a broader populace believe that some degree of centralization is necessary to maintain the nation’s cohesiveness. The emergence of linguistic States serves as evidence for the opposing position, which holds that acknowledging and advancing decentralization would promote unity. On the other hand, although some contend that the Centre only has national interests, or that these interests should come first, others maintain that the Centre’s one-size-fits-all strategy is ineffective and invasive in a society with such broad diversity.
The previous groups would contend that the Centre’s governance standards are superior to those in most States, if not all of them. To attain full decentralization, some support fortifying local entities at the sub-State level. Others contend that we ought to adhere to the Constitution’s original meaning, which called for setting up a Union of States under a dual polity structure, with the Union at the centre and the State Governments at the margins (Article 246)11. While some contend that the Union is bound by the Directive Principles of State Policy, others maintain that these principles are equally obligatory at every level.
10 M.G. Rao, Invisible Transfers in Indian Federalism, 52 Pub. Fin. = Finances Publiques 429, 448 (1997). https://ideas.repec.org/a/pfi/pubfin/v52y1997i3-4p429-48.html
11 Indian Constitution art. 246
Plans for budgetary transfers and associated policies might have specific goals or more general ones. They might just seek to address the fiscal imbalances, which are described as existing expenses not being completely covered by revenues in the regular course of business. (FRBM Act Preamble)12. Current expenses can include all of them but exclude capital needs, or they might be restricted to expenses not included in the plan (Akerlof, G.A., 1969)13.
To assure equity and encourage balanced growth, it might be quite broad. One of its more achievable and moderate goals may be to facilitate or guarantee the delivery of comparable social or economic services by state governments. Providing every individual, wherever they may reside, with defined public services that meet minimal requirements might be a more practical goal.
Acting under an enabling provision in the Constitution, fiscal federalism cannot be viewed in a vacuum. In 1990, an Inter-State Council was established to discuss policies and disputes following the recommendation of the Commission on Centre-State Relations (Article 263)14, which was presided over by Justice R.S. Sarkaria (ROY, J.G.1990)15.But the body is still nearly completely inert. Furthermore, the Council lost the necessary neutrality as well as the trust of the states when it was absorbed into the Union Home Ministry.
Likewise, in 1992, the Constitution was modified to include local self-governments as a third level. The Amendment gave the Union Finance Commission a responsibility to assist local organizations in accordance with the recommendations made by State Finance Commissions. A key player in fiscal federalism was the Planning Commission, an extra-Constitutional organization established in 1950 by Cabinet Resolution to handle development planning. about its contribution, there are more questions than answers about its replacement by NITI (National Institution for Transforming India) Aayog.
The Governing Council of NITI Aayog and the National Development Council (NDC), which were established by administrative decree, are mentioned only in passing and are essentially non-existent. The Union’s and the States’ capital needs, as well as the recent need for revenue expenditures, must be financed by borrowing (Article 292)16.
12 Fiscal Responsibility and Budget Management Act (FRBM Act), Preamble.
13 G.A. Akerlof, Centre-State Fiscal Relations in India, 4 Indian Econ. Rev. 99, 121 (1969). https://www.jstor.org/stable/29794022
14 Indian Constitution art. 263.
15 J.G. Roy, Sarkaria Commission on Centre-State Administrative Relations in Respect of Public Order Duties, 51 The Indian J. of Pol. Sci. 46, 53 (1990). https://www.jstor.org/stable/41855468
16 Indian Constitution art. 292.
States exercise borrowing restrictions. However, states have been known to circumvent the Central prohibition by lending money through their businesses and providing guarantees. Both the Union and the States entrust their debt management to the Reserve Bank of India. The financial markets are somewhat reassured by RBI’s role as a banker and debt management.
States aren’t permitted borrow funds from external sources under the constitution. This makes sure that States’ foreign liabilities don’t grow beyond levels that can be sustainably incurred, which prevents issues in the external sector (Article 293)17.On this basis, several other emerging nations have had difficulties. Different from other rising economy federations like South Africa, China, Brazil, and Indonesia, the Indian system has different mechanisms for budgetary transfers to sub-national administrations. Compared to India, the majority of these nations’ transfer systems provide the federal government significantly more discretion.
Grants from the upper to lower levels of government are the main form of transfer in these nations, and they are primarily discretionary. Unlike India (Article 270)18, these nations do not have a constitution that specifies how national revenues should be shared. Of course, most federations feature dual taxation systems or different taxation at each level. In India, the plans for transfers to local governments have changed recently, but the plans for transfers between Union States have not. The Finance Commission was established by our Constitution to serve as a five-year fiscal federal relations predictability tool. After the five years, the Commission is free to examine and amend the relationships.
Indian fiscal federalism is continually evolving and altering the current picture has to be completely noticed and understood yet. How the Indian government has handled these changes, how organizations like the Finance Commission have adjusted to them, and how Indian fiscal federalism has held up over time. The Union-State budgetary relations are currently encountering difficulties and are at a crossroads notwithstanding these developments. An attempt is made to outline the general parameters of a future course of action that may concurrently address institutional and policy concerns.
17 Indian Constitution art. 293.
18 Indian Constitution art. 270.
Method-Doctrinal Research:
In crafting my research paper, I employed the doctrinal methodology, a systematic approach commonly utilized by legal researchers to study and analyse legal principles, rules, and doctrines.
Ideas to Strengthen India’s Fiscal Federalism:
The fundamental objectives of national growth and budgetary prudence are balanced with state financial autonomy thanks in large part to India’s fiscal federalism system. The following recommendations seek to strengthen fiscal federalism while upholding responsible budgeting standards and granting states complete financial autonomy:
a) Reassessing the Fiscal Transfers:
To guarantee justice and equity in the distribution of resources, conduct a thorough evaluation of the present system of fiscal transfers between the federal and state governments, including tax devolution and grants-in-aid.
India, for instance, might benefit from studying the Australian fiscal federalism model, in which the Commonwealth Grants Commission evaluates state requirements and fiscal capacity to decide how much money to distribute among them.
b) Enhancing State Revenue Generation:
Encourage states to increase their ability to generate income by taking steps like giving them more freedom to choose how they want to tax their citizens and supporting creative ways to raise money.
For instance, states like Karnataka and Maharashtra have increased their income sources by enacting reforms like the Goods and Services Tax (GST) on professional taxes and entertainment.
c) Promotion of Intergovernmental Coordination:
Provide strong intergovernmental coordination structures to make it easier for the federal and state governments to work together on budgetary issues.
For instance, the Inter-State Council, which the Indian Constitution’s Article 263 envisions, may be resurrected to provide a forum for discussion and the development of agreement on matters related to the budget.
d) Capacity Building and Institutional Strengthening:
Invest in state-level institutional development and capacity building programs to improve fiscal management capacities.
For instance, the World Bank-sponsored budgetary Management Capacity Building (FMCB) initiative in Kerala sought to improve institutional efficacy and budgetary sustainability.
e) Redesigning Fiscal Intergovernmental Businesses:
To guarantee a more open and responsible system for dividing up resources between the federal and state governments, reinforce intergovernmental fiscal organizations such as the Finance Commission.
As an illustration, the 15th Finance Commission’s proposal to form an independent fiscal council might offer knowledgeable supervision and direction on budgetary issues.
f) Encouraging Local Governance and Fiscal Decentralization:
By giving local governments additional financial resources and decision-making authority, you may promote more fiscal decentralization and better equip them to handle demands unique to their respective regions.
An illustration of the effectiveness of decentralized planning is Kerala’s People’s
Planning Campaign, in which local governments are essential to project execution and funding distribution.
g) Fostering State Responsibility and Ownership:
By rewarding fiscal restraint and encouraging responsible financial management, governments might be encouraged to assume fiscal responsibility.
As an illustration, consider the budgetary Responsibility Legislation that several Indian states, including Tamil Nadu and Telangana, have passed. It shows a dedication to budgetary responsibility and discipline.
In summary, promoting fiscal federalism in India necessitates a complex strategy that strikes a compromise between the requirement for strict budgetary guidelines and the necessity of giving states complete financial autonomy. By putting these recommendations into practice and learning from practical experiences, India can improve the framework of fiscal federalism and encourage equitable and sustainable economic growth in all of its states.
Conclusion:
In summary, the analysis of India’s fiscal federalism highlights potential and problems for improving the nation’s framework for economic governance. Although the existing structure has made it possible for the federal and state governments to share resources and duties, there are a number of urgent problems that need to be addressed.
Finding a balance between the general objective of attaining budgetary stability and discipline at the federal level and the states’ desire for fiscal autonomy is one significant difficulty. India has to make sure that states have the financial autonomy to successfully address local needs as it works to enhance its federal structure. States also need to make sure that they follow responsible budgeting guidelines to preserve macroeconomic stability.
Enhancing intergovernmental fiscal institutions like the Finance Commission is also necessary to promote accountability, openness, and efficiency in the distribution of resources. India can reduce inequalities between states and encourage fair resource allocation by reshaping these institutions.
Furthermore, building fiscal federalism may be greatly aided by encouraging fiscal decentralization and giving local governments more authority. The provision of sufficient financial resources and decision-making power to local authorities can enhance the provision of public services and enable the construction of infrastructure customized to meet local requirements.
All things considered, India can create a stronger framework for fiscal federalism that supports economic growth, stability, and equitable development throughout the country by tackling these issues and putting the recommended changes into practice. Prioritizing these changes is essential if policymakers are to guarantee the long-term prosperity and wellbeing of national well-being.