Let us make an in-depth study of the relation between the Centre and the State.
The Constitution of India, adopted in 1950, made a clear distinction between the financial jurisdiction of the Central and the State Governments.
Taxes to be levied by the Centre were enumerated in the Central List and comprised 20 items. Taxes to be levied and collected by the States were mentioned in a separate list. It also consisted of 20 items.
Some of the taxes levied by the Centre were, however, to be collected and revenues from those appropriated by the States, e.g., stamp duties and duties of excise on medicinal and toilet preparations. Some taxes, though levied and collected by the Centre, were assigned to the States, only the cost of collection being recovered by the Centre. Examples of such taxes were the estate duty, terminal taxes on goods, taxes on railway fares and freights and a few others.
The share of each State in the net proceeds of these taxes was to be decided by the passing of Acts by the Parliament. There was another group of taxes to be levied and collected by the Centre the net proceeds of which might be shared between the Centre and the States. Taxes on income other than agricultural income and excise duties mentioned in the Central List belonged to this category.
The Constitution also made provision for the setting up of a Finance Commission by the President within two years interval or even sooner, if considered necessary. The Finance Commission was to consist of a chairman and four members to be appointed by the President. The Parliament could lay down the qualifications necessary for appointment as members of the Finance Commission.
The functions of the Finance Commission are the following:
(i) Making recommendations to the President regarding the distribution of the net proceeds of taxes to be shared between the Centre and the States;
(ii) Laying down the principles for grants-in-aid of States’ revenues to be made by the Central Government from time to time;
(iii) Recommending changes in the conditions of State borrowing from the Centre and in the terms of other financial agreements between the Centre and the States; and
(iv) Giving its views on any other matter which may be referred to it by the President in the interests of sound finance. Recommendations of the Commission were to be placed before the Parliament for consideration and approved.
The First Commission was set up in November 1951 under the Chairpersonship of Mr. K. C. Neogy. Since then, ten more Commissions have been set up. The present system of allocation of resources between the Centre and the States is governed by the recommendations of the Eleventh Finance Commission.
One major avenue of transfer of Central resources to States is through loans and grants for the plan via the Planning Commission on the basis of a formula, called Gadgil formula. Apart from the Central assistance to States and Union Territory, of which 5% is grants, the Centre extends about Rs 8,000 crores of grants for the centrally sponsored schemes operated by States.
Upto 1994-95 only personal income tax and Union excise duties were shareable with States in ratios proposed by the Finance Commission after assessing the revenue and expenditure requirements of States for a five-year period and providing for filling the gaps.
The Tenth Finance Commission (1995-2000) had proposed that all taxes, direct and indirect, levied by the Centre should be shared with States so that States get at least 29% of the total receipts of the Centre. It is against this background that we study the recommendations of the Tenth Finance Commission.