Fiscal Federalism in India — Centre–State Finances, Finance Commission, and GST Federalism

1) Fiscal federalism: meaning

Fiscal federalism studies how functions and finances are divided among levels of government:

• Union (Centre)
• States
• Local bodies (Panchayats/Municipalities)

Core idea: match expenditure responsibilities with revenue powers, and design transfers to address imbalances.

2) Why do fiscal transfers exist? (high-yield)

2.1 Vertical imbalance

Centre often has stronger/broader tax handles, while states have large spending responsibilities (health, education, law & order, etc.).

2.2 Horizontal imbalance

States differ in:

• income levels and tax capacity,
• costs of providing public services,
• needs (population, geography).

Transfers help equalize capacity and ensure minimum public services.

3) Finance Commission (FC): role and significance (very testable)

Finance Commission is a constitutional body that recommends:

1. Tax devolution: share of divisible pool of central taxes to states.
2. Grants-in-aid: for revenue deficit, special needs, local bodies, etc.
3. Principles regarding fiscal management (broadly).