In spite of the attempt, explained earlier, to demarcate the formal roles of the Planning and Finance Commissions on the basis of Plan and non-Plan grants, the substantive part of the duplication of their roles still persists. The dichotomous division of the State budgets into Plan and non-Plan sectors for the purpose of determining Federal aid is at best a fiction since both these sectors are inextricably intertwined. Apart from this, given the dominant role of the Planning Commission, the independence and usefulness of the Finance Commission are very severely circumscribed. Indeed, the modus operandi of central planning in India precludes the Finance Commission from playing the role destined for it by the authors of the Indian Constitution. Hence, the raison d'etre of a separate statutory body, like the Finance Commission which recommends the scheme of transfer of revenues and grants-in-aid to States may be seriously questioned. Under the circumstances, it is reasonable to conclude that the Planning Commission itself is the appropriate agency to ascertain such transfers to State governments.

A related question, in this connection, is whether it is desirable to retain the rather complicated schemes of devolution of financial resources by sharing of Federal income taxes and excise levies, by distribution of estate taxes and additional excises levied by the Federal Government, by grants-in-aid of revenues, by grants under Article 282, etc. If the financial transfers from the Federal Government to the States are in an important measure subservient to the achievement of a comprehensive economic plan, a strong case may be made for the simplification and streamlining of the cumbersome means by which Federal transfers are now made to the States. Would it not be more simple and efficient to accumulate all the resources that the Federal Government can spare into a single fund from which the Planning Commission may recommend a block grant every year to each State? The effectiveness of such a procedure will depend upon the ability of the Planning Commission to insure that each State accomplishes its share of the economic development program with adequate tax effort and economy in expenditure. Such power, if given to the Planning Commission, is bound to result in some compromise of State autonomy which may not be incompatible with the highly centralized framework of the Indian Federation.

A less radical alternative will be to fix a definitive allocation of divisible taxes and excises in the constitution itself and leave grantsin-aid to be determined every year by the Planning Commission after a careful study of the State budgets.

FEDERAL-STATE FINANCIAL RELATIONS IN INDIA *

BY WILFRED PREST**

In view of current discussions of Federal-State financial relations in Australia, it is perhaps worth examining procedures and practices in other Federal countries, partly in order to understand the essential nature of our own problems, and partly in the hope that some of the solutions adopted elsewhere may be applicable here.

With these objectives in mind, the present paper attempts a review of Federal-State financial relations in India. Being a new Federation, India has been able to profit by the experience of others. The Government of India Act of 1935, and the financial arrangements made thereunder, were the products of some of the best British and Indian legal and administrative minds. More recently Independence, Partition, and the formulation of the 1950 Constitution have provided both the opportunity and the necessity to reexamine Federal-State finances in the light of actual experience. The results are of singular interest to other Federal countries, however much they may differ from India in their levels of economic development.

INDIAN FEDERALISM

Professor Wheare has described the Indian Constitution as being "quasi-Federal," principally because the President retains some of the reserve powers formerly vested in the British Viceroys. Indian authorities, however, do not share this view, and point out that the President's powers to take over the government of a State, or to enable the Union Parliament to legislate on State matters, are emergency powers only, akin to "the defense power" elsewhere. It may also be observed that the President is in some sense a servant of the States as well as of the Union, being elected jointly by the members of the Union Parliament and the State Legislatures, the aggregate voting power of the latter being equal to that of the former.3

Perhaps a more distinctive feature of the Indian Federation is that it was created primarily by a process of devolution from the center, as the Nigerian Federation is being created today, and not by a compact between preexisting sovereign States, like the original American Union or the Australian Commonwealth. The devolution of powers

*Reprinted from Economic Record, April 1960. **University of Melbourne.

1 Wheare, K. C., “Federalism” (Oxford, 1946), p. 28.

2 Bhargava, R. N.. "Union Finance in India" (London, 1956), pp. 54-55. See also "Report of States Reorganization Commission" (New Delhi, 1955), par. 150. The President's recent action in Kerala, however, would seem to go somewhat further than this line of argument suggests.

Constitution of India. art. 54 and 55. (Referred to below as I.C.).

4 Cf. Bhargava, op. cit., p. 96. This point has also been made by Professor Hicks in "Report of Commission on Revenue Allocation" (Lagos, 1951), p. 26.

which created the British-Indian provinces began with Lord Mayo's scheme of decentralization in 1870, and culminated in the Government of India Act of 1935, from which the scheme of Federal-State relations embodied in the 1950 Constitution is substantially derived. It is true that after Independence, over 550 princely States were integrated in the Union, but they were in no real position to negotiate the terms on which they acceded. Thus the tradition of a strong center remains and the States derive their existence and powers not from separate charters, but from the same constitutional document as the Federal Government itself.

The position of the States in the Indian Union is well illustrated by the comparative ease with which their boundaries were reorganized in 1956 on a linguistic basis, their number reduced from 27 to 14, and the "disparate status" of Part A, Part B and Part C States abolished." The Constitution gives the Union Parliament power to legislate on State areas and boundaries provided that the legislation is recommended by the President after he has "ascertained" the views of the Legislatures of the States concerned. In 1956, the Congress Party still controlled every State Legislature, but subsequently it lost control of Kerala, and might in the future lose control of other States. Hence it is problematical whether the political climate will continue in the future to be favorable to such sweeping changes. Nevertheless, the purely legal obstacles to a reorganization of the States are obviously much less in India than in (say) Australia, where the Federal Parliament is empowered to legislate on such matters only "with the consent of the Parliament of a State and the approval of the majority of the electors of the State voting".7

A further preliminary point of some importance concerning the financial position of the Indian States is that, unlike the Australian States, they do not have the right to appoint their own Auditor Generals. There is one Comptroller and Auditor General for the whole Federation, and he is appointed by the President. Under the Constitution, however, he is required to report to the President on Union accounts, and to the respective State Governors on State accounts. He cannot therefore be regarded exclusively as a servant of the Union government, and of course he holds office on a judicial tenure. The Indian States are not therefore in the position of having their accounts reviewed by a Central Government department, like British local authorities. The system would appear to combine economy in administration with adequate safeguards for the fiscal independence of the States. It has the further advantage of insuring some measure of uniformity and comparability between the accounts of all governments, since the Comptroller and Auditor General prescribes a standard clas sification in the All-India List of Major and Minor Heads of Account. In practice, differences in accounting treatment still exist. Neverthe

In the 1950 Constitution as originally drafted, Part A States corresponded to the former British India Provinces, Part B States to those princely States that had survived either on their own or in union with others, and Part C States to the former Chief Commissioners' Provinces. See "Report of States Reorganisation Commission," p. 6. 1.C., art. 3.

7 Commonwealth Constitution, sec. 123.

I.C., art. 151.

Some examples are cited by Dr. Bhargava, op. cit., p. 151. See also "Report of the Finance Commission, 1957," p. 70.

less, even if only a measure of standardization has been achieved, the administrative and statistical advantages must be considerable. Certainly if such standardization existed in Australia it would greatly simplify the work of the Commonwealth Grants Commission.

Finally, the borrowing powers of the Indian States are subject to certain important limitations which have the effect of giving the Central Government a monopoly of overseas borrowing, and virtual control over the terms and timing of internal borrowing. The Government of India Act of 1935 had permitted the British Indian Provinces to borrow abroad with the consent of the Central Government, but the 1950 Constitution restricts the States to "borrowing within the territory of India".10 However, if a State has any outstanding indebtedness to the Union government, the consent of the latter is necessary before it can exercise its power of borrowing on the internal market. In fact, all States have borrowed from the Union government, particularly in recent years for purposes connected with the first and second 5-Year Plans, and their borrowing programs are therefore all subject to Federal control. It is true that in Australia also in recent years the Commonwealth has been able to limit the volume of State borrowing, but this is because State loan requirements have exceeded the amounts available from public subscriptions. It is also true that the Australia States do not issue their own securities, and that the Commonwealth borrows on their behalf, but this is done through the machinery of the Loan Council, a joint FederalState body to which there is no parallel in India. There is a still greater contrast between the position of the Indian States and that of the American States or the Canadian Provinces, which enjoy independent and virtually unrestricted borrowing powers.

ALLOCATION OF FISCAL POWERS

In Schedule VII of the Indian Constitution, fiscal powers, along with legislative powers, are exhaustively listed and allocated. The schedule lists 96 Federal powers, 66 State powers, and 47 concurrent powers. A similar degree of precision has been introduced into the constitutions of Malaya and Pakistan, but earlier Federal constitutions were much less specific. Thus the United States Constitution listed the Federal powers in only 18 short paragraphs of Section 8. and the Australian Constitution listed them in the 39 paragraphs of Section 51. In both countries, a large field of residual powers remained with the States. In India few residual powers can have escaped the net cast by Schedule VII, but such as may remain are vested in the Union.11

The allocation of fiscal powers in India follows no such simple rule as that which was implicit in the Canadian Constitution, and perhaps also in the Australian, whereby indirect taxation was a Federal power and direct taxation a State power. Even the almost universal principle that customs and excise duties are a Federal power is subject in India to the important exception that the States are empowered to levy excise duties on alcohol and narcotic drugs. Similarly

10 I.C.. art. 293.

11 I.C.. art. 248.

although the States (or their local authorities) enjoy the right to impose agricultural income taxes, capitation taxes, and taxes on trades and professions, 12 the important powers of taxing corporations and nonagricultural incomes rest with the Union. It should be noted that the Union's receipts from nonagricultural income tax must be, and its excise revenue may be, shared with the States, but these provisions are best regarded as methods of financial adjustment and will be discussed as such below. For the moment, we are simply concerned with the constitutional allocation of fiscal powers.

The pattern of allocation is further complicated by two constitutional provisions under which the Union government is empowered to fix the rates of certain taxes, some of which are collected and retained by the States, while the others are collected by the Union but assigned to the States without passing through the Consolidated Revenue Fund of the Union. In the first category are rates of excise duty on medicinal and toilet preparations containing alcohol and narcotics, and rates of stamp duty on most commercial documents.13 In the second category are transportation taxes, death duties on nonagricultural property, and sales tax on newspapers, newspaper advertisements, and interstate transactions.14

Under the latter power an estate duty on nonagricultural property was introduced by the Union in 1953. Eleven of the States then voluntarily authorized the Union to extend this legislation to agricultural property also.15 The States enjoy exclusive powers with respect to the taxation of agricultural property, but the Constitution empowers two or more States to request the Union Parliament to legislate for them on any State matter. 16 In the States that took advantage of this provision there is, therefore, a unified system of estate duties on both types of property, the rates being fixed and the collections made by the Union, but the proceeds being assigned to the States.

More serious complications arise in connection with the levy of sales taxes which, having been a provincial power under the Government of India Act, 1935, was continued as a State power under the 1950 Constitution. During and after the war, however, the Provinces had raised the rates of sales tax to such an extent as to create much friction and litigation." The Constitution, therefore, while leaving the power to levy sales or purchase taxes with the States, prohibited any State from imposing such a tax on transactions which occurred (a) outside its boundaries, (b) in the course of international trade, (c) in the course of interstate trade, or (d) in respect of goods declared to be essential for the life of the community by the Union Parliament.18 Moreover, as a result of an outcry against a Madras tax on newspapers and a Bombay tax on newspaper advertisements,19 these types of sales tax were included among the taxes which Article 269

13 Under article 276 the latter taxes are subject to a maximum annual rate of Rs 250 per person.

13 I.C., art. 268.

14 I.C.. art. 269.

15 Bhargava. op. cit., p. 201.

16 I.C.. art. 252. By way of contrast the Canadian Supreme Court has ruled that neither the Federal Parliament nor a provincial legislature can delegate its powers to the other. See "Evolving Canadian Federalism" (Duke U.P., 1958), p. 117.

Bhargava, op. cit., p. 225.

18 I.C., art. 286; the Union Parliament passed an Essential Goods Act in 1952. Bhargava, p. cit., p. 80; and Report of Taxation Enquiry Commission (New Delhi 1955), Vol. III, p. 36.