Promoting fiscal federalism


From UPSC perspective, the following things are important :

Prelims level: 101st Constitutional Amendment

Mains level: Paper 2- Fiscal federalism


States are facing financial constraints in the backdrop of lockdown and consequent dwindling revenue collection. The situation also highlights the issues of fiscal federalism in India.

Issues facing fiscal federalism in India

1) Issue of 14% compensation

  • As per the Constitution (One Hundred and First Amendment) Act, compensation on account of the implementation of GST will be available for a period of five years.
  • 14% increment assurance: At the time of introducing the Goods and Services Tax (GST) law assured States a 14% increase in their annual revenue for five years (up to July 1, 2020).
  • But the Union government has deviated from the statutory promise and has been insisting that States avail themselves of loans.
  • The future interest liability of these loans should not be placed on the shoulders of the States.
  • Borrowing limits built into loan: Moreover, the borrowing limit of States, as per the Fiscal Responsibility and Budget Management Act, should not be built into these loans.

2) Conditional increase in borrowing limit

  • Last year, the Union government increased the borrowing ceiling of the States from 3% to 5% for FY 2020-21.
  • But conditions are attached to 1.5% of the 2% of increased ceiling.
  • Attaching conditions for expenditure out of the borrowed amount would clip the wings of the States and goes against the principle of cooperative federalism.

Way forward

  • Introduce special rate: A special rate could be levied for a specified period in order to raise additional resources to meet the challenges posed by COVID-19 with the approval of the GST Council.
  • As per Section 4(f) of Article 279A, the Union government can consider introducing any special rate to raise additional resources during the pandemic (any natural calamity or disaster).
  • The present GST compensation period will end in 2021-22.
  • Increase the period beyond five years:  Compensation beyond five years requires a constitutional amendment.
  • If this period is not increased, it will create serious financial stress to the States, especially to those which require higher compensation.


There is a need for measures on part of the Central government to consolidate fiscal federalism in the aftermath of pandemic and implementation of the GST regime in India.

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