Truly speaking, the fiscal arrangement of any country is largely governed by the political system of the country concerned.

India’s po­litical structure is federal; so its financial sys­tem is also federal in character.

The essence of the federal form of government is that each government (Central, Union Territories and State governments) and local-self government is independent of each other with constitution­ally demarcated functions. What is needed is that each government should have independ­ent sources of revenue and should have com­mand over resources to meet its needs.

The Constitution of India, adopted in 1950, made a clear distinction between the finan­cial jurisdiction of the various governments. The various functions of each government have been delineated into three lists: (i) Un­ion List, (ii) State List, and (iii) Concurrent List. Accordingly, financial powers have been di­vided.


Taxes to be levied by the Centre are enu­merated in the Union List and comprise 20 items. Taxes to be levied and collected by the states are mentioned in the State List. Taxes which have an inter-state base are levied by the Union Government and those with a local base are levied by the State governments. Then there is the Concurrent List falling within the jurisdiction of both the Centre and the states.

1. Sources of Revenue of the Central and State Governments:

The sources of revenue of the Union Govern­ment are classified into two parts:

(i) Tax-revenue, and

(ii) Non-tax revenue.


Let us consider tax revenue only.

Taxes which are levied by the Union Gov­ernment but collected and appropriated by the states are: stamp duties and excise duties on medical preparations containing alcohol or narcotics, service tax introduced in 1994-95.

Taxes which are levied and collected by the Union but the entire proceeds of which are assigned to the States are: succession and es­tate duties, terminal taxes on goods and pas­sengers, taxes on railway freights and fares, taxes on transactions in stock exchange, taxes on the sale and purchase of newspapers and advertisements therein, etc.

Taxes which are levied and collected by the Union but are shared with the States are: taxes on income except corporation tax, etc.


Taxes which are levied, collected and ap­propriated by the Centre or proceeds of which are distributed among the States if situation demands are: union excise, duties on tobacco, match, etc.

The major sources of union taxes are taxes on income other than agricultural income, corporation tax, customs duty, excise duty except alcoholic liquors and narcotics not con­tained in medical or toilet preparations, estate and succession duties other than agricultural land, taxes on the capital value of assets, ex­cept agricultural land of individuals and com­panies, rate of stamp duties on financial docu­ments, taxes on railway freights and fares, ter­minal taxes on goods or passengers earned by railway, sea or air, etc.

Likewise, State Governments have both tax-revenues and non-tax revenues to carry out their functions.

Taxes that fall within the jurisdiction of the Slates are: land revenue, agricultural income tax, succession and estate duties on agricul­tural land, taxes on land and buildings, excise on alcoholic liquors and narcotics, taxes on the entry of goods into a local area, taxes on the consumption and sale of electricity, amuse­ment tax, taxes on vehicles, animals and boats, tools, etc. Taxes that are subject to sales tax on commodities have come under value added tax (VAT) net. VAT, introduced in the fiscal year 2005-06 and imposed on about 550 com­modities, have become the largest source of revenue of the State governments.

2. List of Expenditures of the Central and State Governments:

Lists of expenditures of both the Union and State Governments are also exhaustive. How­ever, expenditure of these two forms of gov­ernments are classified as Developmental Ex­penditure or Plan Expenditure and Non-De­velopmental Expenditure or Non-Plan ex­penditure.

Non-plan expenditure falls under two broad heads, viz. revenue expenditure and capital expenditure. The former comprises interest payments, defence expenditures, sub­sidies, pensions, other general services (like tax collection), social services (like education, health), economic services (like agriculture, energy, industry, transport and communica­tions, science and technology and environ­ment) and grants to States and Union Territo­ries. The latter includes capital expenditure on defence, loans to public sector undertakings, States, Union Territories, and foreign govern­ments.

Expenditures on agriculture, rural devel­opment, irrigation and flood control, energy, industry and mineral resources, science and technology, etc. are included in Plan Expendi­ture. In addition to these, grants for implemen­tation of Five Year Plans to States and Union Territories are also included in plan expendi­ture.

Annual receipts and expenditures of Gov­ernments are shown in the current account of the budget while receipts and expenditures on capital goods are shown in the capital account. In other words, expenditures for all adminis­trative and social services are shown in the revenue or current account of the budget. Ex­penditures on general services, health and education, subsidies, interest payments are all expenditures on the current account.

On the other hand, expenditures for the purpose of creation of capital goods are shown in the capi­tal account. Expenditures on irrigation, rail­way lines, etc. are capital expenditures. These are treated as plan expenditures or develop­ment expenditures.


Fiscal imbalances witnessed in the 1980s brought havoc to the BOP crisis and fiscal indiscipline (measured by revenue deficit, fis­cal deficit, etc.) in the early months of 1991. Correctives were applied in respect of tax-ex­penditure policies of the Government.

The total expenditure—both revenue and capital expenditures of the Union Government—de­clined from 14.7 p.c. of GDP in 1990-95 to 17.9 p.c. in 2004-07. The most dramatic decline took place in capital expenditure (from 4.6 p.c. of GDP in 1990-95 to 2.4 p.c. of GDP in 2004-7). Such decline in capital expenditure resulted in a low growth in infrastructure investment since the mid-1990s.

Distribution of Financial Resources:

The Constitution also makes provision for the set­ting up of a finance commission by the President of India at five years’ interval with the objective of allocating financial resources be­tween the Centre and the States. In other words, the transfer of resources from the Cen­tre to the States is governed by the recommen­dations of the Finance Commission.

However, the present system of allocation of financial resources has created a stir in the economy. Because of the enlargement of du­ties and responsibilities, State Governments think that there have been concentration of fi­nancial powers in the hands of the Central Government. But as far as transfer of resources is concerned, the Union Government is less sympathetic to the State Governments. This has resulted in financial conflicts between the Centre and the States.