Centre–State Relations

Financial relations between the Centre and States form an important part of India’s federal system. While India has a federal structure, the Constitution gives the Union government greater financial powers because it has to perform national functions such as defence, foreign affairs, macroeconomic management, national infrastructure and welfare transfers.

At the same time, States are responsible for many citizen-centric functions such as public health, agriculture, police, local government, irrigation, land, roads and welfare delivery. Therefore, the Constitution provides a detailed framework for the distribution of taxation powers, revenue-sharing, grants-in-aid, borrowing powers and fiscal transfers between the Union and the States.

Constitutional Framework

Financial relations are mainly dealt with in Part XII of the Constitution, particularly Articles 268 to 293. Article 280 provides for the Finance Commission, which recommends the distribution of financial resources between the Union and the States

1.Allocation of Taxing Powers

The Constitution divides taxing powers between the Centre and the States through the Union List and the State List in the Seventh Schedule. Unlike legislative subjects, taxation powers are clearly separated to avoid overlapping taxation.Parliament’s Power to Levy Taxes

• Parliament has exclusive power to levy taxes on subjects mentioned in the Union List (13).
• Important Union taxes include income tax, corporation tax, customs duty, duties of excise on certain goods, taxes on inter-state trade and commerce, and taxes related to foreign trade.

State Legislature’s Power to Levy Taxes

• State legislatures have exclusive power to levy taxes on subjects mentioned in the State List.
• Important State taxes include land revenue, taxes on agricultural income, excise duty on alcoholic liquor for human consumption, taxes on vehicles, stamp duty on certain documents, taxes on electricity, and taxes on professions, trades, callings and employment.
• These taxes help States meet expenditure responsibilities in areas such as health, agriculture, police, local government, roads and welfare delivery.

No Tax Entries in the Concurrent List

• There are no tax entries in the Concurrent List. This means that, normally, there is no concurrent jurisdiction between the Centre and States in tax legislation.
• However, the 101st Constitutional Amendment Act, 2016 created an exception by introducing a special provision for Goods and Services Tax. It gave both Parliament and State Legislatures power to make laws on GST.Thus, GST represents a major example of shared taxation power in India’s federal system.

Residuary Power of Taxation

• The residuary power of taxation rests with Parliament. This means that if a tax is not mentioned in any of the three lists, Parliament has the authority to impose it.
• Using this power, Parliament has imposed taxes such as gift tax, wealth tax and expenditure tax in the past.

Levy, Collection and Appropriation of Taxes

• The Constitution makes a distinction between:
  • Power to levy and collect a tax
  • Power to appropriate or use the proceeds of that tax
• For example, income tax is levied and collected by the Centre, but its proceeds are shared between the Centre and the States.
• This distinction is important because some taxes may be levied by one level of government but collected or appropriated by another.

Restrictions on State Taxing Powers

The Constitution places certain restrictions on the taxing powers of States to maintain national economic unity and prevent conflicting taxation.

Tax on Professions, Trades and Callings

• A State legislature can impose taxes on professions, trades, callings and employments. However, the total amount payable by a person under such taxes cannot exceed ₹2,500 per annum.

Restrictions on Taxing Supply of Goods or Services

A State legislature cannot impose tax on the supply of goods or services in two cases:

• Where such supply takes place outside the State.
• Where such supply takes place in the course of import or export.

Parliament has the power to formulate principles for determining when a supply takes place outside the State or during import or export.

Restrictions on Taxing Electricity

• A State can impose tax on the consumption or sale of electricity.
• However, it cannot impose such tax when electricity is:
  • Consumed by the Centre or sold to the Centre.
  • Consumed for the construction, maintenance or operation of railways by the Centre or a railway company, or sold to the Centre or the railway company for the same purpose.

Taxes Related to Inter-State River Authorities

• A State legislature can impose tax on water or electricity stored, generated, consumed, distributed or sold by an authority established by Parliament for regulating or developing an inter-state river or river valley.
• However, such a law becomes effective only when it is reserved for the President’s consideration and receives his assent.

The Constitution gives the Centre wider and more productive taxation powers, while States are given taxation powers over local and regional subjects. At the same time, restrictions are placed on State taxation to prevent disruption of inter-state trade, import-export activities, railways and national economic integration. This arrangement shows India’s federal structure with a strong Centre, while also ensuring that States have independent sources of revenue.

2.Distribution of Tax Revenues

The Constitution not only distributes taxing powers between the Centre and the States, but also lays down how the proceeds of different taxes are to be collected, appropriated and distributed. This distinction is important because a tax may be levied by one level of government, collected by another, and appropriated or shared differently.

The distribution of tax revenues between the Centre and States can be understood under the following categories.

Taxes Levied by the Centre but Collected and Appropriated by the States(Article 268)

• Under Article 268, certain taxes are levied by the Centre but collected and appropriated by the States.
• This includes stamp duties on bills of exchange, cheques, promissory notes, policies of insurance, transfer of shares and other such instruments.
• The proceeds of these duties do not form part of the Consolidated Fund of India. Instead, they are assigned to the concerned State.

Taxes Levied and Collected by the Centre but Assigned to the States(Article 269)

• Under Article 269, certain taxes are levied and collected by the Centre, but their proceeds are assigned to the States.
• This category includes:
  • Taxes on the sale or purchase of goods, other than newspapers, in the course of inter-state trade or commerce.
  • Taxes on the consignment of goods in the course of inter-state trade or commerce.
• The net proceeds of these taxes do not form part of the Consolidated Fund of India. They are assigned to the concerned States according to principles laid down by Parliament.

GST on Inter-State Trade or Commerce: Article 269A

• Article 269A was inserted by the 101st Constitutional Amendment Act, 2016.
• It provides that Goods and Services Tax on supplies made in the course of inter-state trade or commerce shall be levied and collected by the Centre.
• However, this tax is divided between the Centre and the States in the manner provided by Parliament, on the recommendations of the GST Council.
• Parliament is also empowered to formulate principles for determining:
  • When a supply of goods or services or both takes place in the course of inter-state trade or commerce.
  • The place of supply.
• This provision forms the constitutional basis of Integrated GST, or IGST.

Taxes Levied and Collected by the Centre but Distributed Between Centre and States (Article 270)

• Under Article 270, certain taxes are levied and collected by the Centre but distributed between the Centre and the States.This is the most important category of tax-sharing and forms the basis of tax devolution.
• This category includes all taxes and duties referred to in the Union List except:
  • Duties and taxes mentioned under Articles 268, 269 and 269A.
  • Surcharges on taxes and duties mentioned under Article 271.
  • Any cess levied for specific purposes.
• The manner of distribution of the net proceeds of these taxes is prescribed by the President on the recommendation of the Finance Commission.
• In simple terms, Article 270 provides the constitutional basis for sharing the divisible pool of Union taxes with the States.

Surcharge on Certain Taxes and Duties for the Purposes of the Centre (Article 271)

• Under Article 271, Parliament can levy surcharges on certain taxes and duties referred to in Articles 269 and 270.
• The proceeds of such surcharges go exclusively to the Centre.States do not get any share in these surcharges.
• However, Goods and Services Tax is exempt from this surcharge. This means that surcharge cannot be imposed on GST.

Taxes Levied, Collected and Retained by the States

• These are taxes that belong exclusively to the States. They are enumerated in the State List and are levied, collected and retained by the State governments.
• Important State taxes include:
• Land revenue, 
• Taxes on agricultural income,
• Duties in respect of succession to agricultural land,
• Estate duty in respect of agricultural land, 
• Taxes on lands and buildings,
• Taxes on mineral rights,
• Excise duties on alcoholic liquor for human consumption, opium, Indian hemp and other narcotic drugs,
• Taxes on consumption or sale of electricity, 
• Taxes on the sale of petroleum crude, high speed diesel, motor spirit (commonly known as petrol), natural gas, aviation turbine fuel and alcoholic liquor for human consumption, but not including sale in the course of inter-state trade or commerce or sale in the course of international trade or commerce of such goods
• Taxes on goods and passengers carried by road or inland waterways, 
• Taxes on vehicles,
• Taxes on animals and boats, 
• Tolls, 
• Taxes on professions, trades, callings and employments, 
• Capitation taxes, 
• Taxes on entertainments and amusements to the extent levied and collected by Panchayats, Municipalities, Regional Councils or District Councils, 
• Stamp duty on documents except those specified in the Union List, and 
• Fees on matters included in the State List except court fees.

These taxes provide States with independent revenue sources to perform their responsibilities in areas such as health, agriculture, police, local government, irrigation, roads and welfare delivery.

Thus, the Constitution follows a mixed system of tax revenue distribution. Some taxes are levied by the Centre but collected or assigned to the States. Some are levied and collected by the Centre but shared with States. Some taxes are exclusively retained by the Centre, while others belong exclusively to the States.This arrangement reflects India’s model of fiscal federalism, where the Centre has stronger taxation powers, but States are also given constitutional access to revenue through assigned taxes, tax devolution and their own tax sources.

3.Distribution of Non-Tax Revenues

Non-tax revenue refers to the income earned by the government from sources other than taxes. It is an important source of public revenue and helps finance government expenditure without increasing the tax burden on citizens.

A.Non-Tax Revenue of the Union Government (Centre)

Major sources include:

• Posts and Telecommunications
• Railways
• Banking Services
• Broadcasting Services
• Coinage and Currency
• Central Public Sector Enterprises (Dividends and Profits)
• Escheat and Lapse*
• Other Administrative and Economic Services

Escheat and Lapse: Property without a legal heir (escheat) and unclaimed property (lapse) vest in the government.

1. Non-Tax Revenue of State Governments

Major sources include:

• Fisheries
• State Public Sector Enterprises
• Irrigation Services
• Forest Resources
• Escheat and Lapse
• Other Administrative, Social and Economic Services

Importance of Non-Tax Revenue

• Reduces dependence on taxation
• Provides additional fiscal space for development expenditure
• Helps finance welfare and infrastructure programmes
• Improves fiscal sustainability
• Encourages efficient utilisation of public assets and services
• Supports resource mobilisation without increasing tax rates

Challenges

• Low cost recovery from public services
• Underpricing of utilities such as water and transport
• Loss-making public sector enterprises
• Poor asset monetisation
• Weak royalty collection and resource pricing
• Political resistance to user charge revision

Non-tax revenue is an important pillar of government finances. A well-designed system of user charges, dividends, royalties, licence fees and efficient asset management can provide stable and sustainable resources for development while reducing excessive dependence on taxation and borrowing.

4.Grants-in-Aid to the States

Grants-in-aid are financial transfers made by the Centre to the States to support their revenue needs, promote balanced development and reduce regional inequalities. They are an important part of Centre-State financial relations.

There are two types of grants-in-aid: Statutory grants and Discretionary grants

• Statutory Grants (Article 275)

Article 275 empowers the Parliament to make grants to the states which are in need

of financial assistance and not to every state. These grants are provided only to States requiring assistance and not necessarily to all States.Different amounts may be granted to different States based on their requirements.These grants are charged on the Consolidated Fund of India every year.

Specific Grants under Article 275

The Constitution also provides specific grants:

• • for promoting the welfare of the scheduled tribes in a state or
  • for raising the level of administration of the scheduled areas in a state including the State of Assam

The statutory grants under Article 275 are given to the states on the recommendation of the Finance Commission.

• Article 282: Discretionary Grants

Article 282 empowers both the Centre and the States to make grants for any public purpose, even if the subject does not fall within their legislative jurisdiction.Under this provision, the Centre makes grants to the states.

Features

• • The Centre is under no constitutional obligation to provide these grants.Their provision is entirely at the discretion of the Union Government.Hence, they are known as discretionary grants.
  • These grants have traditionally been used to support various development programmes and Centrally Sponsored Schemes.

Purpose

• • To provide financial assistance to States for achieving development and plan objectives.
  • To enable the Centre to influence, coordinate and support State actions in line with national priorities and development goals.

Grants-in-aid strengthen India’s cooperative federal framework by addressing fiscal imbalances and supporting developmental needs. While Article 275 grants provide constitutionally backed financial assistance to needy States, Article 282 grants give flexibility to the Centre and States to support broader developmental objectives and national priorities.

5.Goods and Services Tax Council
The GST Council is a constitutional body responsible for making recommendations on matters related to the Goods and Services Tax (GST). It was established under Article 279A of the Constitution by the 101st Constitutional Amendment Act, 2016.

Chairperson

• Union Finance Minister

Vice-Chairperson

• The GST Council members elect a Vice-Chairperson from among themselves for a period they decide.

Members

• Union Minister of State in charge of Revenue or Finance — Member;
• Minister in charge of Finance or Taxation or any other Minister nominated by each State Government — Members.

Voting Pattern

• Weightage of Votes
  • Centre: One-third (33.33%) of total votes.
  • States collectively: Two-thirds (66.67%) of total votes.
• Decision-Making
  • Decisions require a three-fourths majority (75%) of weighted votes present and voting.

Functions of the GST Council

The GST Council makes recommendations on:

1. the taxes, cesses and surcharges levied by the Union, the States and the local bodies which may be subsumed in the goods and
   services tax;
2. the goods and services that may be subjected to, or exempted from, the goods and services tax;
3. model Goods and Services Tax Laws, principles of levy, apportionment of Goods and Services Tax levied on supplies in the course of inter-State trade or commerce under article 269A and the principles that govern the place of supply;
4. the threshold limit of turnover below which goods and services may be exempted from goods and services tax;
5. the rates including floor rates with bands of goods and services tax ;
6. any special rate or rates for a specified period, to raise additional resources during any natural calamity or disaster;
7. special provision with respect to the States of Arunachal Pradesh, Assam, Jammu and Kashmir, Manipur, Meghalaya, Mizoram,
   Nagaland, Sikkim, Tripura, Himachal Pradesh and Uttarakhand; and
8. any other matter relating to the goods and services tax, as the Council may decide.

6.Finance Commission

The Finance Commission is a constitutional body that recommends the distribution of financial resources between the Centre and the States. It plays a key role in maintaining fiscal federalism, correcting imbalances and ensuring equitable development.

Constitutional Provision

• The Finance Commission is provided under Article 280 of the Constitution.
• The President constitutes the Finance Commission every five years or earlier if considered necessary.

Composition

• The Finance Commission consists of:
  • One Chairman
  • Four other members
• They are appointed by the President.

Functions of Finance Commission

It shall be the duty of the Commission to make recommendations to the President as to-

• the distribution between the Union and the Stales of the net proceeds of taxes which are to be, or may be, divided between them under this Chapter and the allocation between the States of the respective shares of such proceeds;
• the principles which should govern the grants-in-aid of the revenues of the States out of the Consolidated Fund of India;
  • the measures needed to augment the Consolidated Fund of a State to supplement the resources of the Panchayats in the State on the basis of the recommendations made by the Finance Commission of the State;
• the measures needed to augment the Consolidated Fund of a State to supplement the resources of the Municipalities in the State on the basis of the recommendations made by the Finance Commission of the State;
• any other matter referred to the Commission by the President in the interests of sound finance.

The Finance Commission is a key institution of India’s fiscal federalism. It balances the financial powers and responsibilities of the Centre and States by recommending tax devolution, grants-in-aid and support for local bodies. Its role is essential for fiscal stability, cooperative federalism and balanced regional development.

7.Protection of States’ Financial Interests

To safeguard the financial interests of the States, the Constitution provides that certain Bills can be introduced in Parliament only on the recommendation of the President.

These include:

• A Bill that imposes or varies any tax or duty in which States are interested.
• A Bill that varies the meaning of the expression “agricultural income” for the purposes of income tax laws.
• A Bill that affects the principles on which money is or may be distributed to the States.
• A Bill that imposes any surcharge on specified taxes or duties for the purposes of the Union.

Tax or Duty in Which States Are Interested 

The expression refers to:

• A tax or duty whose whole or part of the net proceeds is assigned to any State; or
• A tax or duty from whose net proceeds payments are made to States from the Consolidated Fund of India.

Net Proceeds

Net proceeds = Gross proceeds of a tax or duty – Cost of collection

The net proceeds of a tax or duty are:

• Ascertained and certified by the Comptroller and Auditor General (CAG) of India.
• The CAG’s certificate is final and binding.

Significance

• Protects States from unilateral changes in revenue-sharing arrangements.
• Preserves the federal balance in financial matters.
• Ensures consultation through the President before altering taxes affecting State revenues.
• Strengthens fiscal federalism and State autonomy.

8.Borrowing by the Centre and the States

The Constitution regulates borrowing powers of the Centre and the States to maintain fiscal discipline and financial stability.

Borrowing by the Centre

Under Article 292, the Union Government can borrow:

• Within India
• Outside India

upon the security of the Consolidated Fund of India.

Such borrowing must be within the limits fixed by Parliament.

The Centre may also give guarantees for loans, subject to limits fixed by Parliament.

Borrowing by the States

Under Article 293, State Governments can borrow:

• Within India only
• On the security of the Consolidated Fund of the State

A State cannot borrow outside India.

A State may also give guarantees for loans, subject to limits fixed by the legislature of that state.

Centre’s Control over State Borrowing

A State cannot raise any loan without the consent of the Centre if:

• any part of a loan given by the Centre to that State is still outstanding; or
• the Centre has given a guarantee for any loan taken by that State.

In such cases, the Centre may also impose conditions while granting consent.

This provision gives the Union Government a degree of control over State borrowing and helps maintain fiscal discipline.

Financial Assistance by the Centre to States

The Union Government can:

• Make loans to any State.
• Give guarantees for loans raised by any State.

Any sums required for making such loans are charged on the Consolidated Fund of India.

9.Inter-Governmental Tax Immunities

To maintain the federal balance, the Constitution grants certain tax immunities to the Union and the States, preventing one level of government from taxing the property and functions of the other.

Exemption of Central Property from State Taxation (Article 285)

• The property of the Union is exempt from all taxes imposed by a State or by any authority (such as municipalities, district boards, panchayats, etc )within a State.
• Parliament, however, has the power to remove or modify this exemption by law.
• The term “property” has a wide meaning and includes:
  • Land and buildings
  • Movable and immovable property
  • Tangible and intangible assets
  • Shares, debts, securities and other assets having monetary value
• The exemption applies irrespective of whether the property is used for:
  • Sovereign functions (e.g., defence establishments, armed forces installations), or
  • Commercial purposes (e.g., government-owned commercial properties).

Exception

• Government companies and statutory corporations created by the Central Government do not enjoy this immunity from State or local taxation.
• This is because a corporation or company is a separate legal entity distinct from the Union Government.

Exemption of State Property and Income from Central Taxation (Article 289)

• The property and income of a State are exempt from Union taxation.
• This immunity applies to income earned from both:
  • Governmental (sovereign) functions, and
  • Commercial activities carried on by the State.

Exception

• Centre can impose taxes on a trade or business carried on by a State, or on any operations connected with it, if  the Parliament so provides.
• However, the Parliament can declare any particular trade or business as incidental to the ordinary functions of the government and it would then not be taxable.

No Immunity for Certain Entities

The following are not exempt from Union taxation:

• Local authorities within a State (municipalities, panchayats, etc.).
• State-owned corporations and government companies.

Supreme Court Clarification (1963 Advisory Opinion)

The Supreme Court held that the constitutional immunity of States does not extend to customs duties and excise duties.

Therefore, the Union Government can levy:

• Customs duty on goods imported or exported by a State.
• Excise duty on goods produced or manufactured by a State.

10.Effects of Emergencies on Centre–State Financial Relations

During normal times, Centre–State financial relations operate through tax distribution, grants-in-aid, borrowing rules and Finance Commission recommendations. However, these financial arrangements undergo changes during emergencies.

• National Emergency

During a National Emergency under Article 352, the President can modify the constitutional distribution of revenues between the Centre and the States.

This means the President may:

• • reduce or cancel the transfer of finances (both tax sharing and grants-in-aid) from the Centre to the states. 

Such modification continues till the end of the financial year in which the Emergency ceases to operate.

• Financial Emergency

During a Financial Emergency under Article 360, the Centre can issue directions to the States.

These directions may require the States to:

• • observe specified canons of financial propriety;
  • reduce salaries and allowances of all classes of persons serving in the State;
  • reserve Money Bills and other Financial Bills for the consideration of the President.

Thus, during emergencies, India’s financial federalism temporarily becomes more centralised. The Union gets greater control over State finances to maintain national stability, financial discipline and coordinated crisis management.