Hindu Editorial Analysis : 8-February-2024

The recent financial turmoil in Kerala has sparked a heated debate about fiscal federalism in India. The Kerala government has accused the Central Government of creating a severe financial crisis by imposing strict limits on the state’s borrowing capacity. This situation highlights significant issues within the fiscal federal structure of the country.

Understanding Fiscal Federalism

Fiscal federalism refers to how financial responsibilities are divided among different levels of government. In India, this includes:

  • Three-tier structure: India has a federal structure with central, state, and local governments, similar to the USA and Australia.
  • Fiscal Transfers: The core of fiscal federalism in India is the transfer of funds from the central government to state governments.

The Indian Constitution, particularly Articles 268 to 281, outlines how revenue is distributed between the Union and the States, largely based on recommendations from the Finance Commission. This distribution includes both tax devolution and grants.

Key Issues in Fiscal Federalism

Centre’s Borrowing Ceiling

Kerala has taken its fight to the Supreme Court, arguing that the Centre’s imposition of a Net Borrowing Ceiling (NBC) violates Article 293 of the Constitution. This Article states that:

  • States need the Centre’s consent to raise loans if they have outstanding loans from the Centre.
  • The central government cannot legislate on the public debt of states, as this falls under the State List.
Growing Dependence on Central Revenue

States in India are increasingly reliant on central government funds. This trend has notable implications:

  • Revenue Decline: The share of independent revenue for states decreased from 55% in 2014-15 to 50.5% in 2020-21.
  • GST Impact: The introduction of the Goods and Services Tax (GST) has further limited states’ ability to generate their own revenue. Most indirect taxes have been absorbed into the GST framework.
Loss of Tax Authority

Since the GST implementation, states can no longer set tax rates independently for many areas. This restriction means that:

  • States cannot adjust tax rates based on their specific needs.
  • Increased reliance on central funds has become necessary for development.

Challenges with Cesses and Surcharges

Another emerging issue is the rising share of cesses and surcharges in the overall divisible revenue. Key points include:

  • Non-tax revenues are often excluded from the divisible pool, leading to inequitable financial distribution.
  • States face further financial constraints as they cannot fully tap into all revenue sources.

Why In News

The Kerala government has accused the Centre of pushing the State into a severe financial crisis by imposing a limit on its borrowings, arguing that this restriction undermines its ability to fund essential services and development projects.

MCQs about Kerala’s Financial Crisis and Fiscal Federalism in India

  1. What has the Kerala government accused the Centre of doing to its finances?
    A. Providing too much financial support
    B. Imposing limits on its borrowings
    C. Increasing state revenue
    D. Expanding tax authority
    Correct Answer: B. Imposing limits on its borrowings
    Explanation: The Kerala government has accused the Centre of pushing the state into a financial crisis by imposing strict limits on how much it can borrow.
  2. Which articles of the Indian Constitution govern the distribution of revenue between the Union and the States?
    A. Articles 250 to 260
    B. Articles 268 to 281
    C. Articles 300 to 310
    D. Articles 293 to 300
    Correct Answer: B. Articles 268 to 281
    Explanation: Articles 268 to 281 of the Indian Constitution deal with the distribution of revenue and the fiscal responsibilities between the central and state governments.
  3. How has the introduction of the Goods and Services Tax (GST) affected the states’ ability to generate revenue?
    A. It has increased their revenue from indirect taxes.
    B. It has allowed states to set their own tax rates.
    C. It has diminished their capacity to generate independent revenue.
    D. It has completely removed all taxes from state control.
    Correct Answer: C. It has diminished their capacity to generate independent revenue.
    Explanation: The GST has absorbed most indirect taxes, limiting states’ ability to generate their own revenue, as they can no longer independently determine tax rates for many subjects.
  4. What is one consequence of the increasing reliance of states on central government funds?
    A. States can easily manage their finances.
    B. States are able to invest more in local projects.
    C. States face constraints in their financial autonomy.
    D. States have gained more tax collection powers.
    Correct Answer: C. States face constraints in their financial autonomy.
    Explanation: As states become more dependent on central government funds, their financial autonomy is significantly constrained, making it difficult for them to address their specific developmental needs effectively.

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