CHAPTER II EVOLUTION OF FISCAL FEDERALISM IN INDIA

Transcription

1 CHAPTER II EVOLUTION OF FISCAL FEDERALISM IN INDIA INTRODUCTION India has chosen a federal structure. Hence the centre state financial relations are based on the principles of federal finance. In the words of R.S.Gal, Broadly speaking the structure of the constitution of India is so unusual and so unique in itself that it is very difficult, if not impossible, to describe it concisely and at the same time precisely. However, it may legitimately be said that our constitution is neither purely federal nor unitary in character. But it is really a mixture of two structures though it leans more in favor of the federal rather than the unitary structure. 1 FEDERAL FINANCE The word federation connotes the union of two or more states. In a federation, the federal Government functions at the national level and the constituent states function at the regional level. Federation may be defined as a, form of political association in which two or more states constitute a political unity with a Common Government, but in which these member states retain a measure of internal autonomy. 2 According to the Encyclopedia Britanica, Federation is a form of Government in which the essential principle is that there is union of two or more states under the central body for certain permanent objectives. 3 Transfer of resources from the central government to the states is an essential feature of the present financial system as the financial resources of the states are so meager. Hence we need to ensure a proper balance between the centre and states. To quote Dr.Ambedkar, it is

2 13 difficult to prevent the centre from becoming strong. Conditions in the modern world are such that the centralization of powers is inevitable. One has only to consider the growth of the Federal government in USA, which, not with standing the very limited powers given to it by the Constitution, has out grown its former self and has over shadowed and eclipsed the state governments. This is due to modern conditions. The same conditions are sure to operate on the Government of India and nothing that one can do will help to prevent it from being strong. On the other hand, we must resist the tendency to make it stronger. It cannot chew more than it can digest. Its strength must commensurate with its weight. It would be a folly to make it so strong that it may fall by its own weight. 4 BEFORE INDEPENDENCE The history of financial relations between the centre and the provinces in India is about a hundred years old. But, as is well known, the Indian states had remained outside the fiscal and financial systems of the rest of the country except for certain arrangements entered into with them by the Government of India regarding such matters as maritime customs, Central excises, posts and telegraphs and railways. 5 During the Pre-Independence period the centre levied only a few taxes, namely the customs, central excise, taxes on income, salt duty and opium cess. The bulk of central tax revenue came from customs duty. India had no independent taxation policy of its own during this period. The taxation policy pursued in Great Britain was adopted in India. During the Pre Independence period, there was no inheritance tax. Salt Duty was

3 considered as a bad tax. During this period, the most important commodity taxation which yielded about 60 percent of the total central tax revenue was 14 customs duties. T.George and W.R. Natu 6 wrote that due to the industrial expansion in the country its imports were mounting up during the period of Pre-Independence. There was no division of resources between the centre and provinces before the Montague-Chelmsford Reforms of Before the enactment of the Indian Constitution in 1950, the evolution of federal fiscal relations in India can be seen in gradual steps. The entire analysis has been divided into the following convenient periods. 1. The period before the Government of India Act 1919 (First Period). 2. The period between the Government of India Act 1919 and the Government of India Act 1935 (Second period). FIRST PERIOD: THE PERIOD BEFORE THE GOVERNMENT OF INDIA ACT 1919 Since the British India had a unitary Constitution, the Indian Federal Finance prior to the First World War can be, more precisely termed as unitary type. This centralization was introduced by The Charter Act of According to it all the decisions regarding administration and finance of Centre as well as provinces were handed over to Governor General of India and his council. The activity of strict central control over Provincial Finances is well described by Strachey brothers in the following sentences. The local governments, which practically carried on the whole administration of the country, were left with almost no powers of financial control over the affairs of their respective provinces, and no financial responsibility. 7

4 Lord Mayo in his famous Resolution 8 first outlined the principles of a Scheme of Financial Decentralization It was in 1871, that some decentralization of finances was granted by Lord Mayo, the then Governor General of India. Powers under certain heads, such as police, jails, registration, roads, education and medical services etc were devolved on the provinces. This decentralization of power was not based on any financial principle, and still the ultimate financial control was vested with the central government. It was in 1877, Lord Lytton, the then Governor General, passed on some heads like excise, land revenue and stamps to the provinces. Under the New Financial Scheme introduced by Lord Ripon in 1882, fixed grant system was abolished and the sources of revenue were classified into three categories, viz. 1. Imperial Heads 2. Provincial Heads 3. Divided Heads The Imperial Heads included the items, such as customs, salt, opium, land revenue and profits from commercial departments. Receipts under this heads were to go completely to the central government. The Provincial Heads included the receipts from law and justice, and public works. Receipts under these heads were to be appropriated by the respective provinces.

5 16 The Divided Heads included excise duties, stamps, forests and registration. Receipts under this category were to be shared equally between the centre and the respective provinces. The settlements of 1904 introduced a fixed revenue percentage for provinces. Provision of famine relief to provinces was an important feature of this settlement. 10 In 1912, Lord Hardinge accepted the recommendations of the Decentralization Committee and introduced the permanent settlements. The forest was given exclusively to the provinces. SECOND PERIOD: THE PERIOD BETWEEN THE GOVERNMENT OF INDIA ACT 1919 AND THE GOVERNMENT OF INDIA ACT 1935 The Government of India was keenly interested in the gradual development of self- governing institutions. In this connection Mr.Montagu visited India during November 1917 and submitted his report on Constitutional Reforms on April 22, 1918, which formed the basis of Government of India Act The Reforms Act of 1919 put the financial relations between the central and the provincial Governments on an entirely new basis. The Montagu Reforms introduced, through abolishing divided heads gave much financial autonomy to provinces. 12 Under the scheme of Montagu Reforms, land revenue, irrigation, excise, forests, judicial stamps were given to provincial governments, and customs, commercial stamps, railway receipts, salt etc were entrusted to the centre. 13 As per this Reform of 1919 the distribution of resources between the centre and the provinces created a deficit to the centre and gave a surplus

6 17 to the provinces. Provincial contributions were necessary to make up this deficit till the growth of central resources made the deficit disappears. This was done under Meston Award. The Government of India Act 1935 which formed the basis for Constitution of India, provided autonomy to the states. Expenditure was largely governed by such requirements as a) Territorial expansion b) External security and c) Internal law and order. The Act of 1935 gave two separate lists of sources of revenue, one for the centre and the other for the provinces. Sir Otto Niemeyer was appointed to recommend a suitable basis for sharing the proceeds of these taxes between the centre and the provinces. This was called as Niemeyer Award. Sir Otto Niemeyer prescribed 50% as the share of the divisible pool of the income tax to be distributed to the provinces. AFTER INDEPENDENCE After independence, the states came under two groups. Part A states were Assam, Bihar, Bombay, Madhya Pradesh, Madras, Orissa, Punjab, Uttar Pradesh and West Bengal and part B states were Hyderabad, Maharastra, Mysore, Pepsu, Rajasthan, Saurashtra and Travancore Cochin. The Post independence taxation can be divided into three main heads, viz. the property taxation, the taxation of corporate income and the commodity taxation. Due to Independence, there was no definite change in any tax. However, the independence changed the percentage shares of income tax to

7 18 be distributed among the provinces. The distribution of income tax proceeds among the provinces was made on the basis of Nieymes Award. But in August 1947, the percentage share of different provinces were slightly changed or shuffled so as to adjust to the changes which were caused in the geography of the country by partition. With a view to bring about administrative convenience minor changes were effected in the rate of custom duties. Independence did not bring about any immediate change in the policy of protection for the industries of the country. The Tariff Board was however, reconstituted in November The Board completed its investigation and submitted the report to the Government of India. FINANCIAL RELATIONS UNDER THE CONSTITUTION The present Constitution provides for a pattern of division which closely resembles that was established by the Act of DIVISION OF FUNCTIONS In India, the division of functions between the centre and the states is the result of fairly a long process of evolution. There are three lists in the Constitution. The Union Government has to perform 97 functions including Defence, Foreign affairs, Shipping, Navigation and Aviation, National highways, Post and Telegraphs, Telephones etc. Sixty six functions have been assigned to state governments including police, public order, public health and sanitation, Hospital, Agriculture, Irrigation and Forests etc. The concurrent list includes fifty seven items such as criminal law, bankruptcy and

8 insolvency, economic and social planning, labour welfare, social securities and price control. 19 DIVISION OF RESOURCES The Constitution of India makes a clear division of fiscal powers between the central and the State Governments. The principles adopted for the classification is that taxes with an inter state base are levied by the centre, while those with a local base are levied by the states. The residuary powers belong to the union. classes: Taxes with union Jurisdiction can, therefore, be divided into four (i) (ii) Taxes which are levied collected and wholly retained by the centre. Taxes which are levied and collected by the centre but the proceeds are shared with states (iii) Taxes which are levied and collected by the centre but the entire proceeds are assigned to the states and (iv) Taxes which are levied by the union but collected and appropriated by the states. Constitution. The union taxes are given in list I, VII th schedule of the VII th schedule. Taxes within the jurisdiction of the states are given in List II of the

9 20 This division of resources and functions between the centre and the states has been made on the basis of efficiency and equity criteria of fiscal federation. 14 Therefore the elastic sources of revenue like personal income tax, corporation income tax, excise duty, customs duty have gone to the centre and the expensive functions have come to the states. As a result of this disequilibrium in the division of powers and functions, financial imbalance has emerged between the centre and states. To off set this financial imbalance the Constitution has made provisions for financial transfers from centre to states. The resources are transferred from centre to states by means of tax sharing, loans and grants in aid. A) Tax Sharing (a) Article 268 deals with taxes levied by union but collected and appropriated by the states. (b) Article 269 enumerates taxes levied and collected by the union but revenue is wholly assigned to states. (c) Article 270 is concerned with the sharing of personal income tax. As per Constitution, sharing of income tax revenue is obligatory. (d) Article 272 explains the provision for permissive sharing of taxes. That is the sharing of tax revenue is not obligatory. It is only discretionary. If centre wishes to share the revenue it can do so. Proceeds of Union Excise duty are shared as per this article.

10 21 B) Loans The states are authorized to raise loans in the market. But they borrow from the Union Government also. The frequency of annual borrowing by the states from the union has considerably increased, during recent years. Borrowings are made, among other purposes, for irrigation, community development, agricultural development, rehabilitation and Industrial housing. The states also deposit with the Union Government certain state and local funds which are in effect loans to the centre and used for general purposes. C) Grants in- Aid The well conceived distribution of the tax powers has left the state governments extremely dependent on the union governments. Hence to remove the inadequacy of states and for meeting their manifold responsibilities, provisions have been made under the Constitution for central Grants in aid to the states. 1. Article 275 lays down provisions for statutory grants. Government of India should provide grants to states whose expenditure exceed their revenue. Different amounts can be given to different states to cover their deficits. 2. Article 282 also provides for grants. This is known as discretionary grant as it is provided according to the discretion of the union government. It is also known as public purpose grant as it is given for such purposes.

11 22 D) Finance Commission Under the provisions of the Constitution, President is required to appoint a Finance Commission once in five years. The functions of the Commissions are to make recommendations to the president in respect of (i) The distribution of net proceeds of taxes to be shared between union and the state, and the allocation of share of such proceeds among the states. (ii) The principles which should govern the payment by the union of grants in aid to the states and (iii) Any other matter concerning financial relations between the union and the states. The appointment of the finance commission is of great importance for it enables the financial relations between the centre and the units to be altered in accordance with changes in need and circumstances. The elasticity of relationship introduced by this provision has great advantage. So with the objective of reducing vertical and horizontal inequalities the finance commissions are making recommendations for sharing income tax, excise duties and providing grants statutory as well as others. E) Planning Commission By Stretching the Phrase, Public purpose of Article 282 the central grants to the states towards the implementation of the plan schemes is made. However, it is open to question whether the use of Article 282 as the main channel for the massive grants extended to the states is really intended by the Constitution. The Constitution which was inaugurated only a few

12 23 months before the creation of Planning Commission did not anticipate the implications of planning on state finances and make specific institutional arrangements for central assistance for state plans. Planning commission was brought in to existence by an Act passed by the Parliament of 15 th March As it is a creation of the Union Government, it is not a constitutional body. The planning commission, without a constitutional status, has been playing a powerful role in centre state economic relations by (i) ensuring adequate mobilization of physical and financial resources for the plans (ii) influencing the size and priorities of state plan so as to ensure that they do not function in divergence from the national perspective (iii) making an effort to reduce inter-state disparities and (iv) making an effort to secure some what uniform rate of economic growth and social transformation. To achieve these objectives the Planning Commission is allocating resources among different sectors and different states. The Grants in aid provided by the Planning Commission and Government of India are accompanied by specific conditions (i.e.) they are conditional grants. They are specific purpose grants or block grants mostly with matching components. Arbitrariness prevailed in determining the components and matching pattern of assistance. In the words of Prof. M.K.Thavaraj, Until Fifth Plan, the Planning Commission was assisted by programme advisers who, with the data at their disposal, tried to rationalize and moderate the state plans after due consultations with the central ministries and the representatives of the state

13 24 governments. In the course of finalization of the annual plan the programme Advisers used to determine the composition and extent of central assistance such as the proportion of grants and loans as well as the matching ratios, these procedures involved a large element of discretion and political bargaining which inevitably led to a lot of irritation and dissatisfaction. 15 As a result of this, a lot of heat was generated between centre and the states. In 1967, the National Development Council was forced to set up a committee to evolve an equitable formula of plan assistance acceptable to all the states. The outcome of this committee is called the Gadgil Formula. As per Gadgil formula, the central assistance will be given 30% as grants and 70% as loan. The central assistance will not be related to specific schemes or programme under state plan but will be given as block grants. The loan component of the central assistance becomes the main source of debt burden to the states. The Gadgil formula was followed up to Fifth plan. Since then to adhere to overall plan priorities outlays on certain specific schemes were made compulsory. This increased the arbitrary elements in the central assistance and the central grip over state finance has become tightened in recent years.

14 REFERENCES 1. R.S. Gal: Administrative relations between the union and the states, Jain, Kashyap and Sriniwasan (ed) The Union and the States, P Quoted by Dr.B.P.Tyagi: Public Finance (Jai Prakash Nath Publications, Meerut), 1976, P Encyclopedia Britannica: Vol. 9, P Constituents Assembly Debates: Vol.VII, P Government of India: Report of the Finance Commission, 1952, P Quoted by R.N.Tripathi: Federal Finance and Economic Development in India (Sterling Publishers, New Delhi), 1981, P Quoted by A.K. Gaur: Centre State Financial Relations and Finance Commissions (Chugh Publications, Allahabad), 1985, P Government of India Resolution No.334 Dated 14 th December K.T.Shah: Federal Finance in India (Taraporevala, Bombay) 1929, P B.R.Misra: Indian Provincial Finance (Oxford University Press, London), 1942, P Sudha Bhatnagar: Union State Financial Relations and Finance Commissions (Chugh Publications, Allahabad), 1979, P Government of India: Report of the Finance Commission, 1952, P Veda Doss: Impact of Planning on Centre State Financial Relations in India (National Publishing House, New Delhi), 1978, P Richard A.Musgrave and Peggy B. Musgrave: Public Finance in Theory and Practice (Mc Graw Hill Ltd., New York), 1983 P M.J.K. Thavaraj: Financial Administration of India (Sultan Chand & Co., New Delhi), 1978, P