The Constitution of India outlines the relationship between the Union and States in three primary areas: legislation, administration, and finance. After the introduction of the Goods and Services Tax (GST) – the most transformative tax reform since India gained independence – the financial dynamics between the Union and the States have significantly shifted. This marked a pivotal evolution in financial relations between centre and state.
The Constitution And The Federal Structure
The Constitution of India provides a comprehensive and intricate framework for the allocation of powers between the union and the states.
A comprehensive set of 56 Articles (ranging from Article 245 to Article 300) is dedicated to the intricate dynamics of Union-State relations. These Articles are divided into two distinct Parts, namely Part XI and Part XII.
Part XI, encompassing Articles 245 to 263, delves into the legislative and administrative aspects of these relations.
On the other hand, Part XII, comprising Articles 264 to 300, provides a detailed account of the financial dimensions of the relationship between the Centre and the States.
In terms of legislative relations, the Constitution establishes a dual distribution of legislative powers. The first pertains to territory, while the second pertains to subject matters.
Article 245 (1) precisely delineates the territorial jurisdictions, providing a clear demarcation, “Subject to the provisions of this Constitution, Parliament may make laws for the whole or any part of the territory of India, and the Legislature of a State may make laws for the whole or any part of the State.”
The Constitution divides powers between the Union and the States into three lists of subjects, as mentioned in the Seventh Schedule. These lists are: (i) Union List, (ii) State List, and (iii) Concurrent List. This allocation ensures a clear delineation of responsibilities, allowing for effective governance at both levels.
In addition, the Union Government is granted residual powers under Article 248, which stipulates, “Parliament has exclusive power to make any law with respect to any matter not enumerated in the Concurrent List or State List”.
In matters of administration, the allocation of powers between the Union and the States mirrors the distribution of legislative powers. In essence, a State’s administrative powers coexist harmoniously with its legislative powers, working in tandem to govern effectively.
Articles 256 to 263 encompass a range of provisions that establish the necessary framework for ensuring the efficient and effective functioning of the administrative machinery. These provisions encompass various aspects such as the obligations of States and the Union, the Union’s control over States in specific circumstances, and the establishment of the Inter-State Council. These measures are put in place to address contingencies as they arise, ensuring a smooth and well-regulated governance system.
Articles 264 to 300 enumerate various aspects of financial relations between centre and state.
Financial Relations Between Centre And State
The Constitution of India provides a comprehensive framework for the allocation of revenue between the Centre and the States. It delineates the authority for revenue generation and expenditure obligations for both the Union and the States. The distribution of revenue is governed by the three Lists outlined in the Seventh Schedule of the Constitution.
The Union is entitled to the revenue generated from taxes listed in the Union List, while the States possess exclusive jurisdiction over taxes specified in the State List.
The Concurrent List includes no taxes.
Regarding revenue-sharing, the states retain the entire proceeds of taxes within the State List, while they may be allowed to retain, either wholly or partially, the proceeds of certain taxes in the Union List.
The Constitution entrusted the Union with the responsibility of levying taxes on a nationwide scale, aiming to establish a unified economic landscape free from internal obstacles to the greatest extent feasible.
States, being closer to the people and better attuned to local needs, have been given functional responsibilities that sometimes necessitate expenditures exceeding their allocated revenue sources.
Moreover, disparities among States can be attributed to various factors, including historical backgrounds, uneven resource distribution, socio-economic composition, regional positioning, and the ability to generate resources.
The Indian Constitution incorporates the following provisions, both enabling and mandatory, to rectify these imbalances by facilitating the transfer of resources from the Centre to the States:
- Levy of certain duties by the Union, but collected and appropriated by the States (Article 268).
- Certain taxes and duties levied and collected by the Union but assigned in whole to the States (Article 269).
- Service tax levied by the Union and collected and appropriated by the Union and the States.
- Statutory grants-in-aid of the revenues of States (Article 275).
- Grants for any public purpose (Article 282).
- Loans for any public purpose (Article 293).
Taxes are imposed and shared between the Union and the States, with the distribution of revenue guided by the recommendations of the Finance Commission.
Finance Commission
The Finance Commission serves as a distinctive mechanism to rectify the disparities in revenue and expenditure between the Union and State Governments. These imbalances emerge due to a mismatch between the power to generate revenue and the functional responsibilities of the respective governments.
The Commission is entrusted with the task of achieving this objective by implementing a system of equitable tax-sharing between the Centre and the States, as well as providing grants-in-aid to those States that require such assistance.
Article 280 of the Constitution provides for the constitution of the Finance Commission by the President to make recommendations on “the distribution between the Union and the States of the net proceeds of taxes which are to be, or maybe, divided between them”, “the allocation between the States of the respective shares of such proceeds” and “the principles which should govern the grants-in-aid of the revenues of the States out of the Consolidated Fund of India”.
The Finance Commission’s role has expanded following the 73rd and 74th Constitutional amendments, acknowledging the rural and urban local bodies as the third tier of government. This recognition has brought about a broader scope and responsibility for the Finance Commission in governing the financial affairs of these local bodies.
Article 280 (3) (bb) and 280 (3) (c) of the constitution require the Commission to propose measures to enhance the Consolidated Fund of a State in order to supplement the resources of Panchayats and Municipalities. These measures are based on the recommendations of the respective State Finance Commissions (SFCs).
The Finance Commission (Miscellaneous Provisions) Act, 1951, was enacted by the Parliament of India, leading to the establishment of the First Finance Commission on 22 November 1951. Since then, a total of fifteen finance commissions have been constituted.
The Fifteenth Finance Commission was constituted in November 2017, with N.K. Singh, a former Member of Parliament and Secretary to the Government of India, serving as its Chairman. It was tasked with providing recommendations for the roadmap of 2020-25. Currently, the implementation of the recommendations put forth by the Fifteenth Finance Commission is underway.
Fourteenth Finance Commission
The Fourteenth Finance Commission (FC-XIV) was constituted in January 2013 to provide recommendations for the period 2015-20. Chaired by Dr. Y. V. Reddy, the Commission proposed a significant increase in the allocation of tax devolution to the states, raising it to 42 percent of the divisible pool. This move aimed to enhance the financial resources available to the states and empower them in their respective domains.
The Fourteenth Finance Commission adopted the following criteria and weights to determine the shares of taxes between states.
The decision of the Fourteenth Finance Commission to increase tax devolution from the divisible pool was grounded in the following rationale:
The Fourteenth Finance Commission was tasked with considering the total revenue expenditure requirements of the States, without differentiating between plan and non-plan schemes.
As part of its recommendations, the Commission had to incorporate the grants for State plan schemes (known as the Gadgil formula grants), which amounted to 5.5% of the divisible pool.
Furthermore, according to the commission’s analysis, there was a notable increase in the Union Government’s revenue expenditures on State subjects, rising from 14% to 20% between 2002-05 and 2005-11. Similarly, expenditures on Concurrent subjects also experienced growth, expanding from 13% to 17%.
15th Finance Commission
The 15th Finance Commission, chaired by Mr. N. K. Singh, was tasked with submitting two reports. The initial report, which contained recommendations for the financial year 2020-21, was presented to Parliament in February 2020. Subsequently, on February 1, 2021, the final report with recommendations for the 2021-26 period was also tabled in Parliament.
Key recommendations highlighted in the 2021-26 report include:
Share Of States In Central Taxes
For the 2021-26 period, it is recommended that the share of states in the central taxes remain at 41%, the same as the previous period of 2020-21. This percentage is slightly lower than the 42% share recommended by the 14th Finance Commission for the period of 2015-20. The adjustment of 1% is intended to accommodate the newly formed union territories of Jammu and Kashmir, as well as Ladakh, using the resources of the center.
Horizontal Devolution
Based on principles of need, equity and performance, the overall devolution formula is as follows.
Regarding horizontal devolution, XVFC recognised that the Census 2011 population data aligns more accurately with the current requirements of the states.
However, in order to acknowledge and incentivise states that have made progress in terms of their demographic performance, XVFC has assigned a weight of 12.5% to this criterion.
XVFC has implemented the tax effort criterion once again to incentivise and recognise exemplary fiscal performance.
Goods And Services Tax (GST)
The Goods and Services Tax (GST) is, indeed, the most significant tax reform in India’s indirect tax system. Historically, the States accounted for approximately 60% of the total indirect taxes collected in the country. This was roughly the entire own tax revenues of the States.
Introduced in 2017, the Goods and Services Tax (GST) grants the power to levy and collect taxes to both the Centre and the States. The implementation of GST required amendments to the Constitution, specifically the 101st Constitutional Amendment.
Constitution (One Hundred and First) Amendment Act, 2016
The Goods and Services Tax (GST) was incorporated into the Indian economy through the Constitution (One Hundred and First Amendment) Act, 2016. This amendment brought about changes to the Seventh Schedule of the Constitution, paving the way for the implementation of the GST.
Enacted as The Constitution (One Hundred and First Amendment) Act in 2016, this amendment introduced the national Goods and Services Tax (GST) in India from July 1, 2017. Initially proposed as the One Hundred and Twenty-Second Amendment Bill (122nd Amendment) of the Constitution of India in 2014, it received approval in 2016 and was subsequently renumbered in the statute as The Constitution (101st Amendment) Act, 2016 by the Rajya Sabha.
Both the Central and State Governments have been granted the rights of taxation, as specified in the Union List and the State List, respectively. In order to introduce GST into the Constitution, it was crucial to amend the Union and State Lists, which led to the insertion of Article 246A. This amendment formed the foundation for the implementation of GST, ensuring a streamlined and unified tax system.
The tax now shall be levied as Dual GST separately but concurrently by the Union (central tax – CGST) and the States (including Union Territories with legislatures) (State tax-SGST)/Union Territories without legislatures (Union territory tax-UTGST).
The Parliament/Central Government possesses the sole authority to impose GST (integrated tax-IGST) on inter-State trade or commerce, encompassing imports of goods and services.
The Central Government has the power to levy excise duty in addition to the GST on tobacco and tobacco products.
As of now, petrol and diesel are not included in the Goods and Services Tax (GST) framework. Instead, they are subject to Value-Added Tax (VAT), central excise duty, and central sales tax. Additionally, natural gas and ATF also fall under the same taxation categories.
The implementation of the Constitutional amendment paved the way for the establishment of the GST Council. Following this amendment, the tax bases of both the Central and State governments have been consolidated, allowing for the collection of taxes by both levels of government from this unified base.
Introduction of GST also necessitated four laws, namely, CGST Act, UTGST Act, IGST Act and GST (Compensation to States) Act, which have been passed by the Parliament and since been notified on 12 April 2017. All States and Union Territories with legislatures have already passed their respective SGST Acts.
The entire Goods and Services Tax (GST) system is supported by a resilient IT infrastructure. To this end, the Government has established the Goods and Services Tax Network (GSTN), which offers front-end services and develops back-end IT modules for States that have chosen to participate.
Central and State taxes subsumed under GST are:
- Central Excise Duty
- Duties of Excise (Medical and Toilet Preparations)
- Additional Duties of Excise (Goods of Special Importance)
- Additional Duties of Customs (commonly known as CVD)
- Special Additional Duty of Customs (SAD)
- Service Tax
- Cesses and surcharges in so far as they relate to the supply of goods and services
State taxes subsumed under GST include–
- State VAT
- Central Sales Tax
- Purchase Tax
- Luxury Tax
- Entry Tax ( All forms)
- Entertainment Tax and Amusement Tax (except those levied by the local bodies)
- Taxes on a advertisements
- Taxes on lotteries, betting and gambling
- State cesses and surcharges in so far as they relate to the supply of goods and services.
GST Council
The introduction of the Goods and Services Tax (GST) through a constitutional amendment also entails the establishment of the GST Council. Within 60 days of the GST Act’s commencement, the President of India is required to form this council, with the Union Finance Minister serving as the Chairperson.
The Council’s membership includes the Union Minister of State Revenue or Finance. The other members of the Council are to be the Union Minister of State Revenue or Finance, and the Minister in charge of Finance/Taxation of each state government
As per Article 279A, the GST Council, which will be a joint forum of the Centre and the States, consists of the following:
- Chairperson — The Union Finance Minister
- Member — The Union Minister of State, in-charge of Revenue or Finance
- Members — The Minister in-charge of Finance or Taxation or any other minister nominated by each State Government.
As prescribed in the Article 279A(4), the Council shall make recommendations to the Union and the States on important issues related to GST, including GST rates, the goods and services that may be subjected or exempted from GST, special rate for raising additional resources during natural calamities/disasters, special provisions for certain States, etc. One-half of the total number of members of the GST Council forms quorum in meetings of the GST Council.
Every decision within the GST council must be made with a majority of no less than three-fourths of the weighted votes cast.
The Centre holds one-third of the total voting weightage, while the combined weightage of all the States accounts for two-thirds of the total votes cast.
All decisions made by the GST Council have been reached through consensus, without the need for a vote. This collaborative approach ensures that every decision is carefully considered and agreed upon, upholding the spirit of unity and cooperation.
The GST Council holds a paramount position, particularly in the realm of Centre-State financial relations. With its constitutional mandate and far-reaching implications, the GST Council is poised to play a pivotal role in shaping the country’s federal structure in the years to come.
Salient Features Of GST
The Goods and Services Tax (GST) is an extensive indirect tax imposed on the supply of goods and services in India. Let’s delve into some of the notable aspects of GST:
One-Nation-One-Tax: The implementation of the Goods and Services Tax (GST) in India replaced several indirect taxes imposed by both the Central and State Governments. This move aimed to achieve a unified tax structure across the nation, eliminating the cascading impact of multiple taxes such as excise duty, service tax, and value-added tax (VAT).
By bringing about uniformity in taxation, GST has contributed to a more efficient and streamlined system.
Dual Structure: The Goods and Services Tax (GST) operates with a dual structure. It consists of the Central GST (CGST), imposed by the Central Government, and the State GST (SGST), imposed by the State Governments.
For Inter-state transactions, the Integrated GST (IGST) is applicable. The IGST is collected by the Central Government and then distributed to the respective State. Importing goods or services is treated as inter-state supplies and is subject to IGST, in addition to the relevant customs duties.
Destination-based Tax: GST is a tax that is levied at each stage of the supply chain, from the manufacturer to the consumer, making it a destination-based tax. It is applied to the value added at each stage, facilitating a smooth flow of credits and alleviating the tax burden on the end consumer.
Input Tax Credit (ITC): GST enables businesses to utilise input tax credit, allowing them to claim credit for the tax paid on inputs used in the production or provision of goods and services. This mechanism effectively prevents double taxation and significantly reduces the overall tax liability.
GST would apply on all goods and services except Alcohol for human consumption.
GST on five specified petroleum products (Crude, Petrol, Diesel, ATF & Natural Gas) would be applicable from a date to be recommended by the GSTC. Tobacco and tobacco products would be subject to GST.
In addition, the Centre would have the power to levy Central Excise duty on these products. Exports are zero-rated supplies. Thus, goods or services that are exported would not suffer input taxes or taxes on finished products.
Threshold Exemption: Small businesses in India with a turnover below a specified threshold (currently ₹ 20 lakhs for suppliers of services/both goods and services, and ₹ 40 lakhs for suppliers of goods within a state) are exempt from GST.
For certain special category states, the threshold for suppliers of goods and/or services varies between ₹ 10-20 lakhs. However, in Jammu & Kashmir, Himachal Pradesh, and Assam, the threshold is ₹ 20 lakhs for suppliers of services or both goods and services, and ₹ 40 lakhs for suppliers of goods (Intra-State). This threshold plays a crucial role in alleviating the compliance burden on small-scale businesses.
Composition Scheme: The composition scheme is designed for small taxpayers with a turnover below a specified limit (currently ₹ 1.5 crores and ₹ 75 lakhs for special category states). This scheme allows businesses to pay a fixed percentage of their turnover as GST while benefiting from simplified compliance requirements. It provides an opportunity for small businesses to manage their tax obligations more efficiently, fostering ease and convenience in their operations.
Online Compliance: GST introduced an online portal, the Goods and Services Tax Network (GSTN), for registration, filing of returns, payment of taxes, and other compliance-related activities. It streamlined the process and made it easier for taxpayers to fulfill their obligations.
Anti-Profiteering Measures: To ensure that consumers reap the benefits of GST, the government established the National Anti-Profiteering Authority (NAA). The NAA diligently monitored and prevented businesses from engaging in unfair pricing practices and profiteering as a result of GST implementation. Effective from December 1, 2022, all GST anti-profiteering complaints are now addressed by the Competition Commission of India (CCI).
Increased Compliance and Transparency: The goal of GST is to improve tax compliance by integrating more businesses into the formal economy. The tax system’s transparency, achieved through digitization of processes and electronic records, aids in the prevention of tax evasion and promotes transparency.
Sector-specific Exemptions: Certain sectors, including healthcare, education, and essential commodities like food grains, either enjoy exemption from GST or benefit from reduced tax rates. This approach aims to enhance affordability and accessibility while ensuring the preservation of the original intent.