Fiscal Federalism is a concept that defines the financial relationship and division of fiscal powers between the Union and State governments in a federal structure, aiming to balance state autonomy with national coherence. The term was introduced by economist Richard Musgrave in 1959. In India, the foundation for this concept was laid by the Government of India Act, 1935, which provided a rudimentary pattern for the fiscal arrangements later adopted in the Constitution of 1950. The system was created to address the inherent vertical imbalance—where the Union has access to more buoyant taxes, but the States have greater expenditure responsibilities—and the horizontal imbalance—the disparities in resources among the States.
The mechanism is primarily governed by Part XII of the Constitution, specifically Articles 268 to 293. The Seventh Schedule divides taxation powers into the Union List, State List, and Concurrent List. The key institution is the Finance Commission (FC), a constitutional body established under Article 280, which is mandated to recommend the distribution of the net proceeds of taxes between the Union and the States (vertical devolution) and the allocation of shares among the States (horizontal devolution) every five years. The FC also recommends Grants-in-Aid to States under Article 275 to address revenue deficits and specific needs.
A major recent change occurred with the introduction of the Goods and Services Tax (GST) in July 2017 through the One Hundred and First Amendment Act, 2016. This amendment introduced Article 246A, which grants concurrent power to both the Parliament and State Legislatures to levy GST, and established the GST Council (Article 279A) as a joint decision-making body. The GST subsumed several central and state taxes, including State Value Added Tax (VAT) and Central Excise Duty, which has reduced the independent taxation authority of State governments. However, the principle of mandatory sharing of all Union taxes (except cesses and surcharges) with the States, established by the 80th Constitutional Amendment in 2000, remains a core feature of the devolution framework.