BharatNotes What is Fiscal Federalism?
Fiscal federalism describes how financial powers and responsibilities are distributed across the tiers of a federal system. In India it operates between the Union, the 28 States, the Union Territories and the third tier of panchayats and municipalities. The core challenge it addresses is a structural mismatch: the Constitution gives the Centre the more buoyant taxes (corporation tax, income tax), while States shoulder the bulk of spending on health, education, agriculture and law and order. Bridging this gap — the "vertical imbalance" — and the gap between richer and poorer States — the "horizontal imbalance" — is the central task of Indian fiscal federalism.
Constitutional Framework
The architecture sits mainly in Part XII (Articles 264–293) of the Constitution.
| Provision | Function |
|---|---|
| Article 270 | Sharing of net proceeds of Union taxes (the "divisible pool") between Centre and States |
| Article 271 | Union's power to levy cesses and surcharges — kept entirely by the Centre, outside the divisible pool |
| Article 280 | Finance Commission, constituted every five years, recommends tax devolution and grants-in-aid |
| Article 279A | GST Council, the apex body for indirect-tax decisions (inserted by the 101st Amendment, 2016) |
The divisible pool comprises Union taxes such as corporation tax, personal income tax, CGST and the Centre's share of IGST, but excludes cesses and surcharges — a long-standing State grievance, as these have grown as a share of gross revenue.
The Finance Commission and Devolution
The Finance Commission makes two types of devolution. Vertical devolution sets the States' aggregate share of the divisible pool; horizontal devolution distributes that share among States by formula.
The 15th Finance Commission (award period 2021–26) fixed the vertical share at 41% (down from 42% under the 14th FC, after Jammu & Kashmir and Ladakh became Union Territories). Its horizontal formula weighted income distance (45%), population-2011 and area (15% each), demographic performance (12.5%), forest and ecology (10%) and tax effort (2.5%).
The 16th Finance Commission (Dr Arvind Panagariya, constituted 31 December 2023) submitted its report for 2026–31 to the President on 17 November 2025; it was tabled in Parliament on 1 February 2026 with the Union Budget. The Centre accepted retaining the vertical share at 41%. Its horizontal formula introduced a new 10% weight for a State's "contribution to GDP" (using the square root of GSDP share), alongside income distance (42.5%), population-2011 (17.5%), demographic performance, area and forest & ecology (10% each). It also recommended about ₹7.91 lakh crore for local bodies for the award period.
Cooperative Federalism and the GST Council
The GST Council under Article 279A embodies cooperative federalism: every decision needs a three-fourths majority of weighted votes, with the Centre holding one-third and the States together two-thirds. This design means neither side can act unilaterally. Critics argue, however, that the loss of independent indirect-taxation power and the rising share of cesses have tilted the balance towards the Centre, keeping fiscal federalism a live debate.
