Federal Financial Relations in India

Summary

Delivered as the First A. D. Shroff Memorial Lecture under the auspices of the Forum of Free Enterprise, K. Santhanam’s address surveys the constitutional architecture of Centre–State financial relations in India and argues that planning has bent that architecture out of shape. After Murarji J. Vaidya’s presidential remarks, which commemorate Shroff’s pioneering work for free enterprise and recall Shroff’s own wish for a talk on changing Union–State financial relations, Santhanam traces the lineage of Indian fiscal federalism from Lord Mayo’s 1870 devolution through the Government of India Act, 1935, into Articles 268–281 of the Constitution.

Santhanam credits the Constituent Assembly drafters — Ambedkar, B. N. Rau, Gopalaswamy Ayyangar and K. M. Munshi — with producing a precise, if cautious, federal scheme in which most taxes are demarcated between Union and States while income-tax and Union excise duties are shareable on the recommendations of a Finance Commission appointed every five years under Article 280. He walks through the work of the first four Finance Commissions (Neogi, Santhanam himself, Rajamannar’s Fourth, and the intervening Third under Mahavir Tyagi), summarising how each handled the divisible pool of income-tax, the basis of distribution between collection and population, the widening of shareable excise duties, the consolidation of loans, and the chronic disagreement over sales tax and the merger of excises and sales tax.

The lecture’s polemical heart is a critique of the non-statutory Planning Commission. Santhanam contends that, because grants under Article 282 and plan transfers have outgrown the statutory grants under Article 275(1), the Planning Commission has effectively displaced the Finance Commission, making federal assistance discretionary, opaque and politically dependent. Quoting the Third Finance Commission and Dr. P. V. Rajamannar’s dissenting minute, he argues that the federal balance has been seriously distorted by overlapping jurisdictions and by loans piling up on States that cannot service them.

Santhanam closes with concrete reform proposals: distribute 75% of income-tax and 50% of all excise duties to the States on a population basis, abolish discretionary grants under Article 282, restrict Union loans to the States, route State borrowing through the Reserve Bank, and write off a slice of existing loans. He warns that without restoring federal financial relations to a definite constitutional and statutory footing, even the disappearance of State autonomy and the slide toward a unitary system may become possible. A closing biographical note on A. D. Shroff and a Forum membership appeal round out the booklet.

Key points

• Inaugural A. D. Shroff Memorial Lecture under the Forum of Free Enterprise, framed by Murarji J. Vaidya’s introductory remarks honouring Shroff as a champion of free enterprise.

• Traces Indian fiscal federalism from Lord Mayo’s 1870 devolution through the Government of India Act, 1935, into Articles 268–281 of the Constitution.

• Praises the Constituent Assembly’s drafting — naming Ambedkar, B. N. Rau, Gopalaswamy Ayyangar and K. M. Munshi — as a ‘masterpiece’ compared to the clumsiness of the 1935 Act on Finance Commissions.

• Summarises the work of the first four Finance Commissions on the divisible income-tax pool, widening of shareable Union excise duties, consolidation of State loans, and the failed proposals for merging sales tax with Union excise.

• Argues that the non-statutory Planning Commission has eclipsed the Finance Commission, with plan grants and Article 282 transfers exceeding Article 275(1) grants and making federal assistance discretionary.

• Cites the Third Finance Commission’s verdict on ‘general weakness of federal-State financial relations’ and Rajamannar’s minute against the Planning Commission’s encroachment.

• Documents the spiralling burden of Union loans on the States — Rs. 44 crores in 1947, Rs. 3,100 crores by the end of the Third Plan — much of it unproductively spent and largely unrecoverable.

• Proposes specific reforms: 75% of income-tax and 50% of excise duties to be shared on population basis; abolish Article 282 grants except to Union territories; restrict Union loans to the States and let them borrow from the RBI; write off Rs. 50 per capita of existing loans.

• Closes with the warning that the federal financial relations must be restored to a definite constitutional and statutory basis lest the creation of Linguistic States and unitary drift extinguish State autonomy.