Module 36. Federalism – Taxation, Budgeting, Emergency Provisions

The Constitution of India establishes a federal system of government in which powers are divided between the Union and the States. This division extends to legislative, administrative, and financial areas, ensuring both levels of government function within their defined spheres. However, unlike the rigid federal systems of countries such as the United States, Indian federalism is marked by a strong unitary bias, allowing the Centre to maintain unity and coordination, especially during crises. The financial relationship, budgeting process, and emergency provisions collectively shape the practical functioning of Indian federalism.

Federalism and the Distribution of Financial Powers

Financial federalism in India is founded on the principle that both the Union and the States require adequate resources to perform their constitutional responsibilities. The division of financial powers is clearly defined under Articles 268 to 293 of the Constitution and the Seventh Schedule, which separates subjects into the Union List, State List, and Concurrent List.

• Union List: The Union Government exercises exclusive powers to levy taxes on matters of national importance such as customs, income (except on agricultural income), excise duties, and corporation tax.
• State List: The States are empowered to levy taxes on property, land, agricultural income, and commodities such as liquor and electricity.
• Concurrent List: Generally, no taxation powers are assigned, but both levels may legislate on subjects such as criminal law or labour welfare.

The Finance Commission (Article 280) plays a pivotal role in determining the distribution of financial resources between the Centre and the States. It recommends the division of tax proceeds, the principles of grants-in-aid, and measures to strengthen fiscal capacity at the State and local levels.

Taxation and Revenue Distribution

The Constitution distinguishes between taxes levied and collected by the Union, taxes levied by the Union but collected by the States, and taxes shared between the Union and the States.
1. Taxes Levied and Collected by the Union (Article 269A, 270):

• Income tax (excluding agricultural income)
• Corporation tax
• Customs and excise duties
• Goods and Services Tax (GST) on inter-State trade

2. Taxes Levied by the Union but Collected by the States (Article 268):

• Stamp duties and excise duties on medicinal and toilet preparations.

3. Taxes Shared Between the Union and the States (Article 270):

• Taxes such as income tax and Union excise duties are distributed between both levels as per the recommendations of the Finance Commission.

The Goods and Services Tax (GST), introduced through the 101st Constitutional Amendment Act, 2016, revolutionised India’s fiscal structure by subsuming most indirect taxes and creating a dual taxation model—Central GST (CGST) and State GST (SGST)—with Integrated GST (IGST) on inter-State transactions. The GST Council, composed of representatives from both the Centre and the States, embodies the principle of cooperative federalism by ensuring joint decision-making on tax rates and policies.

Budgeting in a Federal Framework

Budgeting represents the financial planning and accountability mechanism of the government. Both the Union and State Governments prepare their respective budgets annually to allocate revenues and expenditures.
1. Union Budget (Article 112): The Union Budget, officially known as the Annual Financial Statement, outlines estimated receipts and expenditures for a financial year. It consists of:

• Revenue Budget: Day-to-day income and expenditure (tax and non-tax).
• Capital Budget: Loans, investments, and capital receipts.

The budgetary process involves:

• Presentation by the Finance Minister in the Lok Sabha.
• General Discussion and Voting on Demands for Grants.
• Passage of the Appropriation Bill (for withdrawal of funds) and Finance Bill (for taxation measures).

Funds of the Union are managed under three key heads:

• Consolidated Fund of India (Article 266): The chief fund for all revenues and loans.
• Contingency Fund of India (Article 267): Used for unforeseen expenditure.
• Public Account of India: Holds funds belonging to individuals or institutions (e.g., provident funds).

2. State Budgets: States follow a similar budgeting process, with the Governor presenting the Annual Financial Statement in the State Legislature. The funds are similarly structured as the Consolidated Fund of the State, Contingency Fund of the State, and Public Account of the State.
Budgeting ensures financial accountability and promotes fiscal discipline within the federal structure, while also maintaining transparency in governance.

Emergency Provisions and Federalism

The Emergency Provisions (Articles 352–360) give the Union Government the authority to assume greater control in times of national crisis. These provisions temporarily transform the federal system into a more unitary framework to safeguard national stability.
1. National Emergency (Article 352):

• Can be declared on grounds of war, external aggression, or armed rebellion.
• The Centre assumes legislative power over State subjects, and the distribution of revenues can be altered.
• Fundamental Rights under Article 19 are automatically suspended, and Parliament’s term may be extended.
• Examples include the 1962 (China war), 1971 (Pakistan war), and 1975 (internal disturbance) emergencies.

2. President’s Rule (Article 356):

• Imposed when a State government fails to function according to constitutional norms.
• The State Legislative Assembly may be suspended or dissolved, and the President assumes all executive and legislative powers.
• The Union Parliament legislates for the State during this period.
• The Supreme Court in S. R. Bommai v. Union of India (1994) limited misuse of this power by introducing judicial review.

3. Financial Emergency (Article 360):

• Declared when the financial stability or credit of India or any part thereof is threatened.
• The President may direct States to reduce expenditure or salaries of government officials, including judges.
• Though never proclaimed in India, it provides the Union with sweeping fiscal powers during crises.

These provisions ensure the continuity of governance and security of the nation, even at the cost of temporarily curbing State autonomy.

Cooperative and Competitive Federalism

Contemporary Indian federalism has evolved from a centralised model to one of cooperative federalism, emphasising coordination between the Union and States through institutions such as:

• Finance Commission
• GST Council
• Inter-State Council (Article 263)
• NITI Aayog, which replaced the Planning Commission and promotes partnership-based development.

Simultaneously, competitive federalism encourages States to compete in policy innovation, fiscal management, and governance performance, thereby enhancing overall national efficiency.