India is the largest democracy with federal form of government. The fiscal arrangements in India have evolved in a quasi-federal system to meet the requirements of centralized planning in a mixed economy structure and their sources of revenue for both Centre and State were clearly demarcated with regard to the financial relationship and the responsibilities between them. Our constitution provides residual powers to the Centre and makes clear division of fiscal powers between the Centre and the State Governments. Through various source of revenue to government, the Constitution of India provides for the establishment of a Finance Commission for the purpose of allocation of certain resources of revenue between the Union and the State Governments. The Finance Commission is established under Article 280 of the Constitution of India by the President. The Article 264 and 293 explain the financial relations between the Union and the State Government. Although the states have been assigned certain taxes which are levied and collected by them, they also share in the revenue of certain union taxes and there are certain other taxes which are levied and collected by the Central Government but whole proceeds are transferred to the states. In India, the Centre-State financial relationship relates to the distribution of power in resource mobilization between the Centre and States as also the sharing of expenditure responsibilities. During the last decade the disparities widened among the States which became economically and politically important. This situation resulted due to globalization and privatization by which certain States enjoy great advantages over the other. The most important and buoyant revenue sources are assigned to the Union Government, while major expenditure responsibilities rest with the State government, which take care of the social and economic sectors. Hence, in the federal structure, there is the possibility of conflicts in sharing the revenue and expenditure of both the governments. While the State governments in India collects about one-third of the total tax revenue accruing to the government sector, their expenditure obligations are disproportionately high, accounting for three fourths of the aggregate social expenditure and more than one-half of the aggregate expenditure on economic services. To enable the States to carry out their expenditure respective responsibilities, the Finance Commission is assigned with the task of recommending the transfer of resources from the Centre to the States. Fiscal imbalance Viz., vertical or horizontal fiscal imbalance appears very often in the countries with decentralized fiscal systems. Removal of these fiscal imbalances of the States by optimizing social welfare of the economy is to remove the fiscal balance in the inter-government transfers from the Centre by finance commission entrusted in equalization of transfers of funds according to the economic requirement irrespective of the political parties ruling. The real challenge of any federation is to eliminate intra-regional vertical and horizontal fiscal inequalities. This paper analyzes these aspects of vertical and horizontal fiscal imbalance in federal India and the way out to the problem to development path.
1. FISCAL FEDERALISM:
As a subfield of public economics, fiscal federalism is concerned with "understanding which functions and instruments are best centralized and which is best placed in the sphere of decentralized levels of government" (Oates, 1999). In other words, it is the study of how competencies (expenditure side) and fiscal instruments (revenue side) are allocated across different (vertical) layers of the administration. An important part of its subject matter is the system of transfer payments or grants by which a central government shares its revenues with lower levels of government. As originally defined by Musgrave (1959) and Oats (l972), "fiscal federalism" concerns...
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