FINANCIAL RELATIONS BETWEEN CENTRE AND STATE IN THE LIGHT OF

CONSTITUTION

ABSTRACT

The states in India were not only weak but also poor and unevenly developed. So the
founding fathers of Indian Constitution spent a lot of effort in designing the financial
relations between Union and states which are reasonably rigid in a flexible mould. The
Constitution devotes two parts one on the allocation of resources and the second on the
distribution of grants in aid between Union and the state. The Constitution has provided a
reasonably long list of Union and state resources of revenue and has then classified them how
these resources will be mopped up or realized for transfer to the treasuries of the Union and
state governments. This arrangement has deliberately been left open to be revised and
readjusted to the fluctuations of national and state economies by a Finance Commission.

INTRODUCTION

Although, an expert and independent body, the Finance Commission is an agency of Centre
and the state have to appear before it for the augmentation of their revenue resources. The
centre has a built-in advantage and the grants-in-aid arrangements that states will have to
present their case before the commission determines the quantum and character of these
grants. Obviously the sources of the Union government are more elastic while the state
governments, not withstanding their political colours have to satisfy themselves with
traditional services which are too meagre to meet the developmental burdens.

Resources of the Union government include corporation tax, currency, coinage and legal
tender, foreign exchange, duties of customs including export duties, duties of excise on
tobacco and certain goods manufactured or produced in India, estate duty in respect of
property other than agricultural land, fees in respect of any of the matters in the Union List,
but not including any fees taken in any court, foreign loans, lotteries organised by the
Government of India or the government of a state, post-office savings bank, post and
telegraph, telephones, wireless, broadcasting and other like forms of communication,
property of the Union, public debt of the Union, railways, rates of stamp duty in respect of
bills of exchange, cheques, promissory notes, etc., Reserve Bank of India.

RESOURCE ALLOCATION
Taxes on income other than agricultural income, taxes on the capital value of assets,
exclusive of agricultural land, of individuals and companies, taxes on the sale or purchase of
newspapers and on advertisements published therein, terminal taxes on goods or passengers,
carried by railways, sea or air, and taxes other than stamp duties on transaction in stock
exchanges and future markets.

In contrast to this, huge resources that the state sources of finance enumerated in the Consti-
tution are capitation taxes, duties in respect of succession to agricultural land, duties of excise
on certain goods produced or manufactured in the states such as alcoholic liquid, opium, etc.,
estate duty in respect of agricultural land, fees in respect of any of the matters in the State
List, but not including fees taken in any court, land revenue, rate of stamp duty in respect of
documents other than those specified in the Union List, taxes on agricultural income, taxes on
land and buildings, taxes on mineral rights, subject to limitations imposed by Parliament
relating to mineral development, taxes on the consumption or sale of electricity, taxes on sale
and purchase of goods, taxes on advertisements other than those published in newspapers,
taxes on vehicles, taxes on animals and boats, tax on goods and passengers carried by
roadways and waterways, taxes on trades professions, taxes on luxuries, tolls and taxes on
employment, entertainment and gambling. The Indian Constitution follows the 1935
arrangement in classifying the levying, collection and appropriation of these resources which
are exclusively assigned or are shared between the Union and the states.

This five-fold distribution is as follows:

(1) Taxes exclusively assigned to the Union:

In this category, certain items of revenue have been exclusively assigned to the Union. These
include customs and export duties, income tax, excise duties on tobacco, jute, etc.,
corporation tax on capital value of assets of individuals and companies; estate duty and
succession duty in respect of property other than agricultural land; and income from the
earning departments like the Railway and Postal departments.

(2) Taxes exclusively assigned to the states under Article 269:

This category contains items of revenue which fall under the exclusive jurisdiction of the
state. These are: land revenue; stamp duty (except on documents included in the Union List);
succession duty and estate duty; taxes on goods and passengers carried by road or inland
waters; consumption or sale of electricity; tolls; taxes on employment; duties on alcoholic
liquors for human consumption, opium, India hemp and other narcotic drugs; taxes on the
entry of goods into local area; taxes on luxuries, entertainments, amusements, betting and
gambling, etc.

(3) Taxes leviable by Union but collected and appropriated by states under Article 268:

The revenue from the following items is collected and appropriated by the states. Stamp
duties on bills of exchange, cheques, promissory notes, bills of lading, letters of credit,
policies of insurance, transfer of shares, etc. Excise duties on medicinal, toilet preparations
containing alcohol or opium of Indian hemp or other narcotic drugs. Though all the above
items are included in the Union List and the Union government can levy taxes on them, yet
all these duties are collected by the states and form part of the revenue of the state who
collects them.

(4) Taxes levied and collected by Union but assigned to states under Article 269:

The taxes on the following items are levied and collected by the Union but wholly assigned to
the states within which they are levied.

i. Duties in respect of succession to property other than agricultural land;

ii. Estate duty in respect of property other than agricultural land;

iii. Terminal taxes on goods or passengers carried by rail, sea, or air;

iv. Taxes on railway freights and fares;

v. Taxes other than stamp duties on transactions in stock exchanges and future markets; and

vi. Taxes on the sale or purchase of newspapers and on advertisements published therein.

(5) Taxes levied and collected by Union and shared with states:

The taxes from the following items are levied and collected by the Union government but
shared with the states in certain proportion with a view to securing an equitable distribution
of the financial resources:

i. Taxes on income other than agricultural income;

ii. Excise duties, other than those on medicinal and toilet preparations.
The Constitution provides that the Parliament may by law give grants-in-aid to the needy
states out of the revenue of the Central government. The amount of such grants is determined
by the Parliament in accordance with the needs aim to help such states which need Centres
special support for special kinds of needs and calamities. Knowing well the inelasticity of
states resources and the pressure of development on state exchequers the provision of grants
in aid by the Centre seems justified.

Finance Commission

This need necessitated the provision of a Finance Commission which the President of India
appoints every fifth year:

(1) To assess and fix the allocation of revenue to the Central and state governments, and

(2) To determine the principles and proportions on which the grants in aid can compensate the
revenues of the states.

This ongoing arrangement and distribution of resources by an expert economic body with the
approval of the Parliament presents a democratic solution of the question. If it does not work
well, then Article 360 of the Constitution empowers the President to make a declaration of
emergency stating that a situation has arisen whereby the financial stability or credit of India
is threatened.

The consequences of this declaration are:

(1) During the period, the executive authority of the Union shall extend to the giving of
directions to any state to observe such canons of propriety as may be specified in the
directions.

(2) These directions may include: A provision requiring all Money Bills or other Financial
Bills to be reserved for the consideration of the President. A provision to issue directions for
the reduction of salaries and allowances of all or any class of persons serving in connection
with the affairs of the Union and states including the judges of the Supreme Court and the
High Court.

The duration of such proclamation will be a period of two months; unless before the expiry of
that period, it is approved by resolutions of both houses of Parliament. If the House of the
People is dissolved within the aforesaid period of two months, the proclamation shall cease to
operate on the expiry of 30 days from the date on which the House of the People first sits
after its reconstitution, unless before the expiry of that period of 30 days it has been approved
by both houses of Parliament. It may be revoked by the President at any time, by making
another proclamation.

A. Towards Centralisation:

This prescribed union-state relationship of the Constitution has passed through very many
vicissitudes and strains since 1950. The dependence syndrome of state on the Union
government has caused flutter if not open protests. Several committees and commissions
were appointed even during Nehru era when the governments in most of the states belonged
to the ruling Congress party.

The Planning Commission and its role as an extra constitutional body generated a debate but
the issue could be resolved within the framework of the Constitution. In six years of working
of the Constitution, the India polity witnessed three constitutional amendments Third, Sixth
and Seventh which have a direct bearing on union-state relations.

The Third Amendment Act:

The Third Amendment Act modified item 33 of the Concurrent List and increased the power
of the Union government over the production, distribution, and prices of many commodities
including the foodgrains in 1954.

The Sixth Amendment Act:

The Sixth Amendment Act 1956 added a new item 9-A to the Union List and thereby reduced
the powers of the state legislature with regard to imposition of sales tax by states.

The Seventh Amendment Act:

The Seventh Amendment Act added Section 350-A to the Constitution whereby special
powers were given to the Centre to give primary education to the linguistic minority groups
in their own language. Under this amendment, the Central government was authorised to
appoint a special officer to look after the special interests of the linguistic groups. It also
transferred industries from the State List to the Union List.
Even during Nehru period, the Supreme Court of India following the American convention of
doctrine of implied powers interpreted the Constitution on the assumption that whatever is
not clearly given or assigned to the states may be taken as implied with the centre.

The Supreme Court, held in a number of cases that the Central government was competent to
levy taxes on all those goods and things which were manufactured by the state government.
An autonomous corporation created and controlled by the state government is liable to the
payment of income tax as imposed by the Central government.

It is the jurisdiction of the state government to decide as to which medium of instructions

should be used in the affiliated colleges, but at the same time, this power of the state will
become invalid if it lowers the standard of an institution of higher learning as higher
education is in the domain of the Central government.

Thus, the Supreme Court has taken a stand which has led to the increase of the Central
governments powers at the cost of state activity. The Indian Constitution lays down the rules
of comity, which the units have to observe in their horizontal and vertical relationships. These
rules and agencies relate to matters such as recognition of the public acts, records and
proceedings of each other, extra-judicial settlement of disputes, coordination between states
and freedom of inter-state trade and commerce. It has contributed to the growth of
centralisation in Indian polity.

B. The Pinpricks and Protest:

In the post-Nehru era, the non-Congress coalitions at Centre and states disturbed this union-
state equilibrium with a political jolt. The states mounted their campaigns for increased
autonomy. The Administrative Reforms Commission constituted in 1967 asked the Setalvad
Study Team to make a comprehensive analysis of union-state relations for their
recommendations. It was the beginning of identification of the problem.

Following the ARC report 1969, the Tamil Nadu government constituted a commission to
examine intergovernmental relations under the chairmanship of Justice P.V. Rajamannar in
1969. The provision of Presidents rule under Article 356 was the real hub of controversy
when eleven instances of Presidents rule were witnessed in four years time from 1967 to
1971.
RECOMMENDATIONS FROM COMMISSIONS

The M.C. Setalvad study team of ARC recommended the following:

(1) An inter-state council with five representatives one each from five zonal councils may be
set up.

(2) The office of the Governor be filled by a person having ability, objectivity and
independence and the incumbent must regard himself a creation of the Constitution.

(3) An inter-state council be composed of the Prime Minister and other central ministers
holding key portfolio and chief ministers and others may be invited or co-opted.

(4) Guidelines for the Governor to regulate the exercise of discretionary powers may be
detailed.

(5) The relationship between the Finance Commission and the Planning Commission should
be rationalised.

The Tamil Nadu Rajmannar report of 1971 is another comprehensive document of 282 pages
wherein Justice Rajmannar reopened some of these perennial issues and suggested:

(1) An inter-state council, consisting of chief ministers with Prime Minister as chairman be
set up to resolve inter-state disputes.

(2) The Governor of a state should be appointed in consultation with the state government
and should be ineligible for second term.

(3) The jurisdiction of Article 356 pertaining to Presidents rule be restricted to avoid its
abuse by the Centre.

(4) Some subjects from Union List be transferred to the State List and a redefinition of items
in Union List be attempted.

(5) The residuary powers of legislation and taxation should be vested in the state legislature.
This crystallisation of issues in union-state relation in the year 1977 promoted the West
Bengal Marxist government to articulate the need for redefinition and a document was
prepared as a charter of demands against the Union government. It picked up specific articles
of the Constitution and suggested varieties of amendment to extend the sphere of state
autonomy.

Some of the major recommendations of West Bengal document on Centre-state relations are
appended below:

(1) The state legislature should have exclusive power to legislate on matters not enumerated
in Union or Concurrent List. For this Article 248 be suitably amended.

(2) The preamble should describe India a Federation of state and the term Union should be
deleted.

(3) Rajya Sabha should be directly elected with equal representation of states and its powers
should be equal with that of Lok Sabha.

(4) Article 302 which restricts states trade and commerce should be deleted.

(5) Article 368 should be so amended as to ensure that no amendment of the Constitution was
possible without the concurrence of two-thirds of the members present and voting in each
house of Parliament.

(6) Languages mentioned in the Eighth Schedule should be allowed in the work of the
Central government and the state governments at all levels. English should continue to be
used for all the official purposes of the Union along with Hindi as long as the people of the
non-Hindi regions so desire.

(7) Article 249 is an encroachment upon state autonomy and should be deleted.

(8) All India services (IAS and IPS) should be abolished and there should be only Union and
state services and Centre should have no jurisdiction over the personnel of state services.

(9) Article 3 of the Constitution should be suitably amended so as to ensure that the name and
area of a state cannot be changed by Parliament to prevent specific conflict between two or
more states in respect to territory.
(10) The special status of Kashmir within the Indian Union, as laid down in Article 370 of the
Constitution should be retained.

(11) Articles pertaining to Presidents Rule, Financial Emergency and Reservation of Bills for
Presidents assent should be done away with.

(12) The Seventh Schedule and its lists should be reformulated and states should have
exclusive control over police, law and order, CRPF, certain categories of industries, etc.

(13) A separate article should be included in the Constitution to constitutionalise the existence
and operations of Planning Commission and National Development Council. The Centre
supervise these organisations to play its role as a coordination agency.

(14) States must be accorded more powers for improving tax on their own and to determine
the units of public borrowings.

C. The Sarkaria Effort:

This West Bengal Document was a well thought out and precisely drafted memorandum and
it aimed to arrest the increasing tendency of centralisation. It went much beyond Article 356
and its implications but covered several maiden areas like all India services. Seventh and
Eighth Schedules and problems of union policy through CRPF. The roles of Governor,
Planning Commission, Finance Commissions, NDC were viewed from the states angle.

The memorandum goes to the extent of suggesting that Union List should contain only five
subjects, namely, (1) Foreign Relations, (2) Defence, (3) Currency, (4) Communications, and
(5) Economic Coordination. The radical suggestions to delete several articles go a long way
to change the basic nature and structure of the Indian Constitution. But the demand for
restructuring Centre-state relations continued unabated by non-Congress states like Andhra
Pradesh, Karnataka, West Bengal, Kerala, Assam, Tripura, Tamil Nadu and Jammu &
Kashmir.

This forced Government of India to set up a commission under the chairmanship of Justice
R.S. Sarkaria to go into the question and recommend appropriate changes within the
constitutional framework in August 1983. The Commission took four years to complete its
deliberations and submitted its report on October 27, 1987. The Commission made a total of
247 recommendations of which 24 were rejected, 10 were not considered wholly relevant and
36 accepted with modifications. One hundred and nineteen recommendations are reported to
have won the governments full acceptance.

The centrist tendency and the office of the Governor in union-state relations dominated the
Sarkaria findings and recommendations.

The Commission felt that:

(1) The chief minister of a state should be chosen by the Governor according to a four-step
formula.

(2) Article 356 should be retained but should sparingly be used after due warning to erring
state.

(3) State legislature should not be dissolve before the Presidential proclamation.

i. Leader of the pre-election alliance.

ii. Leader of the largest single party.

iii. Leader proving his or her majority in front of the Governor.

iv. Leader whom the Governor thinks the House will support or accept.

The other recommendations pertain to more all India services in technical fields and inter-
governmental councils to sort out Centre-state disputes. The dynamics democracy and devel-
opment has significantly changed the framework in which the states now find themselves
operating.

CONCLUSION

It signifies a need for a wide ranging re-examination of Centre-state relations so that they are
enabled to have adequate powers as well as resources to meet their growing patterns of needs.
This should be possible without weakening the Centre. The problems call for greater bi-level
or tri-level sensitivity to the need for sound political processes and conventions in the land.

With the constitutionalisation of the Panchayati Raj in 1993, federalism has become a three-
tier governmental arrangement, and the needs and aspirations of the community-level
government must also be constitutionally monitored. For this, the Constitution has already
created an institutional framework of zonal councils and control boards. Then, there are
informal consultation devices through conferences.

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