Recently, the Chief Minister of Kerala has accused the Central Government of weakening Fiscal Federalism

More on the News: 

  • The Centre has decided to include debt from the public account of the States to calculate the Net Borrowing Ceiling (NBC). 
  • In addition, it has also included the extra-budgetary borrowings by state-owned enterprises, where the principal and/or interest are paid out of the Budget or any other State revenue, in calculating NBC. 
  • Kerala has moved to the Supreme Court, contending that the Centre’s imposition of a Net Borrowing Ceiling (NBC) on the State violates Article 293 of the Constitution.
  • Kerala is particularly upset by the inclusion of debt taken by state-owned enterprises as the State’s own debt. 
  • The Kerala Infrastructure Investment Fund Board (KIIFB), which funds major infrastructure projects through extra-budgetary borrowings, is particularly affected. 
  • With KIIFB’s debt included in the NBC, Kerala contends it can’t finance pensions and welfare schemes. 

About Net Borrowing Ceiling (NBC) 

  • Purpose: The NBC limits the borrowings of States from all sources, including open market borrowings. 
  • Article 293: According to Article 293(3) of the Constitution, the State has to obtain the consent of the Centre to raise ‘any loan’ if ‘any part of the previous loan’ extended by the Centre is outstanding. The imposition of the NBC is done by invoking the powers of the Centre under Article 293(3). 
  • The normal Net Borrowing Ceiling (NBC) of each State is fixed by the Union Government in the beginning of each financial year. 

Differing views over NBC:

  • Central Government’s View: The Union Finance Minister justified the decision by quoting the 15th Finance Commission Report, which says, “Governments at all tiers may observe strict discipline by resisting any further additions to the stock of off-budget transactions and contingent liabilities which is against the norms of fiscal transparency and detrimental to fiscal sustainability.” 
• Kerala Government view: 
  • Parliament does not have the power to legislate upon the ‘Public Debt of the State’ as it is mentioned in Entry 43 of the State List of the Constitution. Thus, the State Legislature has the power to administer the State’s public debt. 
  • The State argued that Article 266(2) of the Constitution indicates that the money collected by the Central or State government, which is unrelated to the Consolidated Fund, can be brought under the heading of ‘Public Accounts’. All activities related to public accounts fall within the domain of the State Legislature, and the Centre has no power to include withdrawals from public accounts in the NBC. 
  • The Kerala Fiscal Responsibility Act, 2003, enacted by the State Legislature, sets the fiscal deficit targets for the State (3% of the GSDP by 2025-2026). Thus, when a State Act provides for budget management and fiscal discipline, it is not desirable to have external supervision on the finances of the State by the Centre. 

What is Fiscal Federalism:

  • Fiscal federalism is how money and responsibilities are divided between different levels of government.
  • It involves deciding what services the central and state governments should provide and how they should pay for them.
  • It also includes figuring out how tax money should be shared between these levels of government and how financial aid should be distributed to ensure fairness and effectiveness. 

Reasons for Erosion of Fiscal Federalism:

• Impact of GST on State Autonomy: States cannot raise tax revenue due to curtailed indirect tax rights under GST, except for petroleum products, electricity, and alcohol.

• Non-Divisive Cess and Surcharges: Despite an increase in devolution from 32% to 41%, as suggested by the Finance Commission, non-divisive cess and surcharges, that are appropriated solely by the Union, have risen significantly. It reduces resources available for transfer to states. 

  • The share of cess & surcharges in the Centre’s gross tax revenues has gone up significantly from 9.43% in 2012 to 15.7% in 2020. 

• Issue of Differential Interest: States borrow at higher interest rates (around 10%) than the Union government’s borrowing rate of about 7%. Union benefits from interest rate differentials, gaining at the expense of states.

• Centrally Sponsored Schemes (CSS): The existence of a large number of CSS requiring states to share their costs. States allocate significant portions (25% to 40%) as matching grants, affecting their priorities.

  • The one-size-fits-all approach of CSS often overrides state-specific schemes, compromising state autonomy.

• Reduction in Corporate Tax: The Union government reduced corporate tax rates from 35% to 25% in 2019. This further impacts the divisible pool of resources. 

Tools for Fiscal Federalism

  • Constitutional Assignment of Powers: The Constitution of India assigns taxation and expenditure powers to different levels of government, ensuring clear demarcation between the central and state governments.
  • Finance Commission: A constitutional body (Article 280) responsible for recommending tax revenue distribution, suggesting ways to enhance state financial resources, and promoting fiscal discipline.
  • Goods and Services Tax (GST): A comprehensive indirect tax replacing multiple central and state taxes on goods and services, administered by a GST Council with representatives from the central and state governments.

Measures to Improve Fiscal Federalism in India:

  • The Fifteenth Finance Commission and Punchhi Commission on Center-State Relations recommended the financial rationalisation of CSS and minimisation of discretionary transfers, particularly those related to CSS. 
  • Transfers from the Union to the States, which fall outside the recommendations of the Finance Commission, should ideally be administered under the purview of the Inter-State Council.
  • Need to re-examine List I and List III entries in the 7th Schedule to align with changes in policy, technology, and societal aspirations.
  • Granting permanent status to the Finance Commission for continuous and effective review of fiscal matters.
  • Inclusion of state-specific targets for fiscal deficit in the Fiscal Responsibility and Budget Management (FRBM) legislation to accommodate varying financial situations of the state.


Addressing these challenges requires the Union to be more accommodative to the needs of the States to uphold the principles of fiscal federalism, ensure equitable distribution of resources, and promote greater fiscal autonomy for states within the framework of India’s federal structure. 

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