Impact of the new economic measures on fiscal ties between the union and states in India.

One Purse, Many Hands

At the stroke of midnight on 30 June 2017, Parliament's Central Hall, which had heard Nehru's tryst with destiny seventy years earlier, hosted the launch of the Goods and Services Tax. It marked a moment when the Union and the States agreed to give up part of their separate taxing powers and pool them in a single tax, the climax of a larger shift. Within three years India had raised the States' share of central taxes, abolished the Planning Commission, recast the centrally sponsored schemes and adopted a common national tax. B.R. Ambedkar had told the Constituent Assembly that the Constitution could be both unitary and federal according to the needs of time and circumstance. The new economic measures have made union-state fiscal ties more interdependent and more negotiated: States receive more money and share a new table of joint decision, but they have surrendered tax autonomy while the Union has recovered control through cesses, conditional transfers and borrowing rules, so the relationship is cooperative in design and contested in practice.

To judge that impact, one must recall the original design. The Constitution gives the Union the most buoyant taxes, such as income and corporation tax, while assigning the States the heavier spending duties of health, policing, agriculture and schooling. A technical paper prepared for the Sixteenth Finance Commission in 2025 estimates that the Union collects about 65 per cent of general government tax revenue while the States account for about 60 per cent of public expenditure. This vertical fiscal imbalance is bridged by the Finance Commission under Article 280 and by grants under Articles 275 and 282. For six decades, the Planning Commission also handed out plan grants with considerable discretion, so the fiscal relationship carried a strong top-down character.

The first wave of change, in 2015, tilted the balance towards the States. The Fourteenth Finance Commission under Y.V. Reddy raised the States' share of the divisible pool from 32 to 42 per cent, and the Fifteenth Finance Commission under N.K. Singh set it at 41 per cent after Jammu and Kashmir became a Union Territory. The Planning Commission gave way to NITI Aayog, a think tank without the power to allocate funds, and the Union Budget of 2017-18 abolished the old distinction between plan and non-plan expenditure. States were to get more untied money and set their own priorities. The flip side came quickly. A Sub-Group of Chief Ministers in 2015 rationalised the centrally sponsored schemes, and most of them moved to a 60:40 sharing pattern (90:10 for the north-eastern and Himalayan States), so States now co-finance national programmes from the very untied funds they had just received.

The second wave, GST, rewired the ties more deeply. The 101st Constitutional Amendment of 2016 inserted Article 246A, giving the Union and the States a simultaneous power to tax goods and services, and Article 279A, creating the GST Council. In the Council the Union holds one-third of the vote and the States together two-thirds, and a decision needs three-fourths of the weighted votes, so neither side can act alone. Its gains are real: a common national market, one return in place of a maze of entry taxes and octroi, a shared technology backbone in GSTN, and a culture of consensus so strong that the Council took its first formal vote only in December 2019, on the tax on lotteries.

Yet GST also exposed the fragility of trust. States gave up VAT, entry tax and several smaller levies in exchange for a promise: the GST (Compensation to States) Act, 2017 guaranteed them 14 per cent annual growth in GST revenue over the 2015-16 base for five years. When the pandemic shattered collections in 2020, the compensation cess fell short, and after a bitter debate the Union arranged back-to-back loans for the States rather than paying from its own funds. Compensation ended in June 2022, leaving several States with a revenue gap and the feeling that the bargain had been one-sided. In Mohit Minerals (2022), the Supreme Court held that the Council's recommendations are persuasive rather than binding. The rate rationalisation of September 2025, which collapsed most rates into two slabs of 5 and 18 per cent, revived State worries about lost revenue.

A quieter trend has shaped the ties as much as GST: the rise of cesses and surcharges, which under Article 270 lie outside the divisible pool. Their share in the Union's gross tax revenue rose from 6.4 per cent in 2011 to 19.7 per cent in 2020-21, as reported by the CAG, and has stayed in double digits since. As a result, while the Finance Commission recommended 41 per cent, the share of the Union's gross tax revenue actually devolved fell from 34.9 per cent in the Fourteenth Commission's period to about 32 per cent in the Fifteenth. Total transfers to States and Union Territories have still grown, from ₹10.85 lakh crore in 2017-18 to a budgeted ₹26.21 lakh crore in 2026-27, but a growing part comes tied: ₹5.2 lakh crore through centrally sponsored schemes and ₹1.85 lakh crore as fifty-year interest-free loans for capital investment, several of them linked to reforms. States now receive more money but with less freedom over how to spend it.

Borrowing, the third lever, tells the same story. The FRBM Review Committee of 2017 proposed a general government debt anchor of 60 per cent of GDP, with 20 per cent for the States, while the UDAY scheme of 2015 shifted three-fourths of the debt of State power distribution companies onto State balance sheets. Article 293(3) requires indebted States to seek the Union's consent to borrow, and from 2022 the Union began counting off-budget borrowings by State entities within their net borrowing ceilings. Kerala challenged this under Article 131, and in 2024 the Supreme Court referred the questions to a Constitution Bench. At the same time, a World Bank study for the Sixteenth Finance Commission shows that market borrowings rose from 21.1 per cent of State liabilities in 2005 to 53.3 per cent in 2019, while loans from the Union fell from 15.8 to 3.5 per cent, so States are increasingly disciplined by markets as well as by New Delhi.

The measures have also sharpened competitive federalism. NITI Aayog's Fiscal Health Index 2025 ranks States on revenue, spending quality and debt, with Odisha at the top with a score of 67.8, and such rankings push laggards to reform. The horizontal question has grown louder too. Southern States argued that the Fifteenth Commission's use of the 2011 population penalised them for controlling population growth, which led the Commission to add a demographic performance criterion. Disputes over withheld Samagra Shiksha funds in 2024-25 showed how scheme conditions can become instruments of pressure.

The fiscal ties have become more cooperative in architecture, since the GST Council and Finance Commission transfers bind both levels into a single fiscal system, and more contested in practice, as suits under Article 131 and public quarrels over dues show. The way forward lies in rebuilding trust through institutions. Cesses beyond a set ceiling could be brought into the divisible pool; the dispute-settlement mechanism that Article 279A itself envisages for the GST Council should finally be created; the Inter-State Council deserves regular meetings; and States must strengthen their own revenues, especially the property tax that funds local bodies, so that autonomy rests on their own base.

The midnight session of 2017 was a promise that India's Union and States would share one purse while each kept its own hands free to serve its people. That promise has been only half kept. Yet the GST Council shows that rival governments can sit at one table and decide together. If the Union treats States as partners rather than as implementing agencies, and States treat fiscal discipline as their own interest rather than an imposition, the federalism that the Supreme Court in S.R. Bommai (1994) counted among the Constitution's basic features can become, in fiscal matters too, a living covenant and the shared engine of a developed India by 2047.