Centre-State financial relations in India, provided under Articles 264–293, define the distribution of taxation powers, grants, borrowing authority, and resource allocation. These relations have continuously evolved with India’s shift from a centralised planned economy to a liberalised system, and more recently to a cooperative federal structure under reforms like GST and Finance Commission devolution.

Evolution of Centre-State Financial Relations in Planned Development

Centralised Planning Era (1950–1991):

• Planning Commission dominated fiscal relations, allocating resources through the Gadgil formula.
• States remained dependent on discretionary central transfers and loans under Article 282.
• National Development Council offered limited state participation but real power stayed with the Centre.
• This led to vertical fiscal imbalance, with states spending more but raising less revenue.

Post-1991 Liberalisation:

• With economic reforms, states gained greater autonomy in resource mobilisation.
• FRBM Act (2003) encouraged fiscal discipline and borrowing limits.
• Role of Finance Commissions increased, shifting devolution from plan to non-plan transfers.
• States began to attract foreign and private investment, reducing sole dependence on Centre.

Impact of Recent Reforms on Fiscal Federalism

Positive Outcomes

• GST Council institutionalised fiscal federalism through joint decision-making.
• Higher tax devolution (41%) provided more flexibility and autonomy.
• Performance-based grants incentivised reforms in power sector, population management, and urban local bodies.
• DBT and digital reforms improved efficiency and reduced leakages, empowering states in welfare delivery.

Challenges Persist

• Vertical fiscal imbalance remains—states incur ~60% expenditure but raise ~40% revenues.
• Centrally Sponsored Schemes (CSS): Conditional transfers restrict true autonomy despite higher devolution.
• GST compensation disputes (post-2020) created tensions, especially during pandemic revenue shortfalls.
• Rising state debts and off-budget borrowings have strained fiscal stability (e.g., Kerala, Punjab).

Going forward, reforms could include raising states’ tax share beyond 41%, ensuring statutory GST compensation, rationalising Centrally Sponsored Schemes, and linking borrowing limits with fiscal discipline. Overall, fiscal federalism reflects a blend of flexibility and central oversight, ensuring national cohesion while steadily empowering states.