By Swastika Goel, Amity Law School, Lucknow.

Co-operative federalism is a concept according to which the National, State and Local governments come together and work collectively so as to solve the common problems together rather than forming different policies for the same issues. The concept of cooperative federalism put forward the view that the national and state governments are partners in the exercise of governmental authority. It is also referred to as the new federalism.

“I feel more and more that we must function more from below than from the top… too much of centralization means decay at the roots and ultimately a withering of branches, leaves and flowers.” -Pandit Jawaharlal Nehru

“We want to promote co-operative federalism in the country. At the same time, we want a competitive element among the states. I call this new form of federalism Co-operative and Competitive Federalism” – Prime Minister Narendra Modi


The Finance Commission is a Constitutional body formulated under Article 280 of the Indian Constitution. It is constituted every five years by the President of India to review the state of finances of the Union and the States and suggest measures for maintaining a stable and sustainable fiscal environment. It also makes recommendations regarding the devolution of taxes between the Centre and the States from the divisible pool which includes all central taxes excluding surcharges and cess which the Centre is constitutionally mandated to share with the States.

The Fourteenth Finance Commission (FFC) was appointed on 2nd January, 2013 under the chairmanship of Dr. Y. V. Reddy. The terms of reference for the commission sought suggestions regarding the principles which would govern the quantum and distribution of grants-in-aid (non-plan grants to states), the measures, if needed, to augment State government finances to supplement the resources of local government and to review the state of the finances, deficit and debt conditions at different levels of government.

The FFC has submitted its recommendations for the period 2015-16 to 2020-21. They are likely to have major implications for centre-state relations, for budgeting by, and the fiscal situation of, the Centre and the States. Some of the major recommendations are as follows:

  • The FFC has radically enhanced the share of the States in the central divisible pool from the current 32 percent to 42 per cent which is the biggest ever increase in tax devolution: One of the core tasks of a Finance Commission as stipulated in Article 280 (3) (a) of the Constitution is to make recommendations regarding the distribution between the Union and the States, of the net proceeds of taxes. This is the most important task of any Finance Commission, as the share of States in the net proceeds of Union taxes is the predominant channel of resource transfer from the Centre to States.
  • The FFC has also proposed a new horizontal formula for the distribution of the States’ share in divisible pool among the States: The divisible pool is that portion of gross tax revenue which is distributed between the Centre and the States. The divisible pool consists of all taxes, except surcharges and cess levied for specific purpose, net collection charges. Prior to the enactment of the Constitution (Eightieth Amendment) Act, 2000, the sharing of the Union tax revenues with the States was in accordance with the provisions of Articles 270 and 272, as they stood then. The eightieth amendment of the Constitution altered the pattern of sharing of Union taxes in a fundamental way. Under this amendment, Article 272 was dropped and Article 270 was substantially changed. The new Article 270 provides for sharing of all the taxes and duties referred to in the Union list, except the taxes and duties referred to in Articles 268 and 269, respectively, and surcharges on taxes and duties referred to in Article 271 and any cess levied for specific purposes.
  • Several other types of transfers have been proposed including grants to rural and urban local bodies, a performance grant along with grants for disaster relief and revenue deficit. These transfers total to approximately 5.3 lakh crore.
  • The FFC has not made any recommendation concerning sector specific-grants unlike the Thirteenth Finance Commission.

The spirit behind the FFC recommendations is to increase the automatic transfers to the States to give them more fiscal autonomy and this is ensured by increasing share of States from 32 to 42 per cent of divisible pool. Assuming the recommendations of FFC were to be implemented as it is, there is concern that fiscal space or fiscal consolidation path of the Centre would be adversely affected. However, to ensure that the Centre’s fiscal space is secured, the suggestion is that there will be commensurate reductions in the Central Assistance to States (CAS) known as “plan transfers.” One immediately noteworthy fact is that CAS transfers per capita are only mildly progressive. The correlation coefficient with state per capita NSDP is -0.29. This is a consequence of plan transfers moving away from being Gadgil formula-based to being more discretionary in the last few years. Greater central discretion evidently reduced progressivity. A corollary is that implementing the FFC recommendations would increase progressivity because progressive tax transfers would increase and  less progressive plan transfers would decline.

Balancing the enhanced fiscal autonomy of the States with preserving fiscal space of the Centre entails reduction in CAS transfers. But there are many ways of doing the latter from the totally discretionary to formula-based. Within the latter too there are many options:

  • proportionate cuts across the states in CAS transfers;
  • ensuring the implementation of legally-backed/mandated schemes and then proportionately cutting the residual;
  • equal per capita distribution of CAS transfers;
  • implementing the legally-backed schemes and then distributing the remaining amount in line with the FFC formula for tax devolution; and many more.

The FFC has made far-reaching changes in tax devolution that will move the country toward greater fiscal federalism, conferring more fiscal autonomy on the States. This will be enhanced by the FFC-induced imperative of having to reduce the scale of other central transfers to the states. In other words, states will now have greater autonomy on the revenue and expenditure fronts. The numbers also suggest that this renewed impulse toward fiscal federalism need not be to the detriment of the Centre’s fiscal capacity. A collateral benefit of moving from CAS to FFC transfers is that overall progressivity will improve.

To be sure, there will be transitional costs entailed by the reduction in CAS transfers. But the scope for dislocation has been minimized because the extra FFC resources will flow precisely to the states that have the largest CAS financed schemes.

In sum, the recommendations of the FFC, along with the creation of the NITI Aayog, will further the Government’s vision of cooperative and competitive federalism. The necessary, indeed vital, encompassing of cities and other local bodies within the embrace of cooperative and competitive federalism is the next policy challenge.