Start Here: The One Problem This Whole Chapter Is Trying to Fix

Before a single Article, understand the problem. It is very simple:

Think of a household where one person earns most of the income, but another person does most of the shopping. Every month, money has to move from the first to the second. How much moves, on what basis, and with what conditions attached — that is the entire subject of Centre–State financial relations.

Economists call this the vertical fiscal imbalance. Every Article from 268 to 293 is a rule about that transfer.

Legislative relations decide who makes the law. Administrative relations decide who does the work. Financial relations decide who holds the purse. Ask any Chief Minister which of the three he worries about most, and you will understand why this is the chapter that actually runs Indian federalism. — Legacy IAS Faculty

Rule Zero: Article 265 — No Tax Without a Law

Article 265: "No tax shall be levied or collected except by authority of law."

In plain English: a government cannot ask you for money just because it wants to. There must be a law passed by a legislature behind every rupee of tax. Not a rule, not an order, not a circular — a law.

And that law must come from the legislature that is allowed to make it. Which brings us to the lists.

The Three Questions That Unlock Everything

This is the single most useful idea in the whole chapter. Most students lose marks because they merge three completely different things.

Imagine a shop. Someone decides the price on the tag. Someone stands at the counter and takes your cash. Someone takes the cash home at night. In a normal shop, that is one person.

In the Constitution, it can be three different governments.

Articles 268 to 271: The Four Ways the Centre's Taxes Are Shared

Article 268 — Centre writes the rule, the State runs the till (and keeps it)

• Collection: by the States.
• Appropriation: appropriated by the States. The proceeds of these duties levied within any state do NOT form part of the Consolidated Fund of India — they are assigned to that state.
• Taxes covered: stamp duties on bills of exchange, cheques, promissory notes, policies of insurance, transfer of shares and others.

Everyday example: the small stamp duty on your insurance policy. Parliament decided the rate. Your State collected it and keeps every rupee. The Centre never touches the money — it never even enters the Union's account.

Article 269 — Centre does the work, the State gets the money

• Collection: by the Centre.
• Appropriation: assigned to the States. The net proceeds do NOT form part of the Consolidated Fund of India; they are assigned to the concerned states as per principles laid down by Parliament.
• Taxes covered: (i) taxes on the sale or purchase of goods (other than newspapers) in inter-state trade; (ii) taxes on the consignment of goods in inter-state trade.

Article 269A — GST on inter-state trade

• Collection: by the Centre.
• Appropriation: divided between the Centre and the States, in the manner provided by Parliament on the recommendations of the GST Council.
• Parliament also formulates the principles for determining the place of supply — i.e. which State a sale "belongs" to.

Everyday example: you order a phone from a seller in another State. That is IGST — Article 269A. The Centre collects it, then splits it with your State. The "place of supply" rules exist to decide whether the money goes to the seller's State or yours. (Answer: yours — GST is a destination-based tax.)

Article 270 — the big one: taxes that are actually shared

• Collection: by the Centre.
• Appropriation: distributed between the Centre and the States. The manner of distribution of the net proceeds is prescribed by the President on the recommendation of the Finance Commission.
• 'Net proceeds' = proceeds of a tax or duty minus the cost of collection.
• Under Article 279, net proceeds are ascertained and certified by the Comptroller and Auditor-General of India — and his certificate is final.
• Covers all taxes and duties in the Union List EXCEPT:
  1. duties and taxes under Articles 268, 269 and 269A;
  2. surcharge under Article 271;
  3. any cess levied for specific purposes.

Everyday example: your income tax. The Centre levies it, collects it — and then 41% of it goes to the States under the Finance Commission's formula. This is the pipeline through which most Central money reaches States.

Article 271 — the Centre's private pocket

• Parliament can at any time levy surcharges on taxes and duties referred to in Articles 269 and 270.
• The proceeds go to the Centre exclusively. States have no share whatsoever.
• However, GST is exempted — a surcharge cannot be imposed on GST.

The Two Amendments That Rewired Tax Sharing

What the States Tax on Their Own

These are levied, collected and kept by States. All three stages, one government. This is the money no one can take away.

Grants: When Sharing Taxes Isn't Enough

Tax sharing alone never balances the books. So the Constitution adds grants — money given, not shared. There are three kinds, and the difference between them is the difference between a salary and pocket money.

Two Rules That Protect the States

Article 274 — the Centre cannot casually tax what States care about

Certain Bills, if introduced in Parliament, need the prior recommendation of the President. These are Bills that:

• Impose or vary any tax or duty in which States are interested
• Vary the meaning of the expression 'agricultural income'
• Affect the principles on which moneys are, or may be, distributable to States
• Impose any surcharge on any specified tax or duty for the purposes of the Centre

In plain English: Parliament cannot quietly slip in a money Bill that damages State finances. Someone has to sign off first. Note the irony, though — the President acts on the advice of the Union Council of Ministers. So the "protection" is the Centre checking itself.

Articles 285 and 289 — governments don't tax each other

Borrowing: What Happens When It Still Isn't Enough

The Finance Commission (Article 280) — and the 16th FC, Live Now

Someone has to decide how much of Article 270's money goes to States, and which State gets what. That someone is the Finance Commission — a constitutional body the President appoints every five years under Article 280.

It answers three questions:

1. Vertical devolution: what share of the divisible pool goes to States as a whole?
2. Horizontal devolution: how is that share split among States?
3. Grants-in-aid: who needs extra help under Article 275?

What the 16th FC decided

• Vertical devolution: 41% — unchanged from the 15th FC. 18 states (including Kerala, Odisha, Haryana, Gujarat, Tamil Nadu) had demanded 50%. Rejected. The Union had asked for "moderation", arguing 49% of gross revenue receipts already reach States.
• The divisible pool excludes cesses, surcharges and the cost of collection — the loophole above, still intact.
• Grants: ₹9.47 lakh crore total — local bodies ₹8 lakh crore (rural ₹4.4 lakh cr, urban ₹3.6 lakh cr) and disaster management ₹2.04 lakh crore.
• Discontinued: revenue deficit grants, sector-specific grants and state-specific grants.
• New: Special Infrastructure Grants (₹56,100 crore) for wastewater management in cities of 10–40 lakh people, and an Urbanisation Premium Grant (₹10,000 crore).
• Fiscal roadmap: Centre's fiscal deficit down to 3.5% of GDP by 2030–31; States capped at 3% of GSDP; off-budget borrowings to be discontinued. Combined debt to fall from 77.3% of GDP (2026–27) to 73.1% (2030–31).
• Reforms urged: privatise DISCOMs (legacy debt into an SPV); rationalise subsidies — unconditional cash transfers are now 20.2% of subsidy spending (2025–26), up from 3% in 2018–19; close 308 inactive State PSEs.
• Transparency: the Union should publish CAG-certified net tax proceeds annually under Article 279.

The horizontal formula — and the one change that matters

The GST Council (Article 279A) — Where the Real Bargaining Happens

GST is the biggest change to Centre–State finances since 1950. States gave up their independent power to tax goods in exchange for a seat at one table: the GST Council.

How the voting actually works — and why it matters

• Centre = 1/3rd of the weighted votes. All States together = 2/3rd.
• A decision needs 3/4th (75%) of the weighted votes of members present and voting.

Are the Council's decisions binding? No.

In Union of India v. Mohit Minerals (May 2022), the Supreme Court held that GST Council recommendations are only recommendatory — NOT binding on the Union or the States. Why? Because Article 246A gives both Parliament and State legislatures simultaneous power over GST. Neither is subordinate.

The Court called Indian federalism a dialogue in which States can disagree — describing it as cooperative federalism that must sometimes be "un-cooperative federalism". The most quotable line available on this topic.

The compensation story — the promise, the pandemic, and the end

What Happens to Financial Relations During an Emergency?

Two of the three emergencies reach into this chapter:

• National Emergency (Article 352): the President can modify the constitutional distribution of revenues between the Centre and the States, and can reduce or cancel the transfer of finances from the Centre to States. Any such modification continues till the end of the financial year in which the Emergency ceases, and every such order must be laid before both Houses.
• Financial Emergency (Article 360): the Union can direct States to observe canons of financial propriety, reduce the salaries of State and Union employees including Supreme Court and High Court judges, and require States to reserve Money Bills for the President's consideration. It has never been declared — not even in the 1991 crisis.
• President's Rule (Article 356): Parliament can authorise the President to sanction expenditure from the State's Consolidated Fund, subject to later parliamentary approval.

Exam Value Addition: Prelims & Mains

Prelims rapid-fire

Practice MCQs

Q1 — Who keeps the money?

Consider the following statements:

1. The proceeds of duties levied under Article 268 form part of the Consolidated Fund of India.
2. Surcharges levied under Article 271 are shared with the States as part of the divisible pool.
3. Under Article 270, the net proceeds of a tax are certified by the Comptroller and Auditor-General, whose certificate is final.

Which of the statements given above is/are correct?

1. 3 only
2. 1 and 3 only
3. 2 and 3 only
4. 1, 2 and 3

Answer: (a) 3 only. Statement 1 is false — Article 268 proceeds do NOT form part of the CFI; they are assigned directly to the State. (The same is true of Article 269.) Statement 2 is the opposite of the truth — surcharges go to the Centre exclusively and are expressly excluded from the divisible pool along with cesses. Statement 3 is Article 279.

Q2 — Grants

With reference to grants under the Constitution, consider the following:

1. Statutory grants under Article 275 are given on the recommendation of the Finance Commission and are charged on the Consolidated Fund of India.
2. Discretionary grants under Article 282 require prior sanction of Parliament.
3. Under Article 282, a State may make a grant to another State.

Which of the statements given above is/are correct?

1. 1 only
2. 1 and 3 only
3. 2 and 3 only
4. 1, 2 and 3

Answer: (b) 1 and 3 only. Statement 2 is false — the defining feature of Article 282 is that it needs no parliamentary sanction; it is an executive power. That is precisely why it became the vehicle for Centrally Sponsored Schemes. Statement 3 is correct and often missed: Article 282 says "the Union or a State" may make grants — so a State can give to a fellow State.

Q3 — Borrowing

Consider the following statements about borrowing under the Constitution:

1. A State may borrow from within India as well as from foreign sources on the security of its Consolidated Fund.
2. Parliament has enacted a law prescribing limits on the borrowing powers of the Union under Article 292.
3. A State that is indebted to the Union cannot raise a fresh loan without the Union's consent.

Which of the statements given above is/are correct?

1. 3 only
2. 1 and 3 only
3. 2 and 3 only
4. 1, 2 and 3

Answer: (a) 3 only. Statement 1 is false — States can borrow only within India; only the Centre can borrow abroad (Article 292). Statement 2 is false and is the sleeper fact: Article 292 says "within such limits as may be fixed by Parliament by law" — but no such law has ever been passed. Statement 3 is Article 293(3), now before a Constitution Bench in State of Kerala v. Union of India.

Q4 — Recent developments

Which one of the following statements is correct?

1. The 16th Finance Commission raised the states' share in the divisible pool from 41% to 50%.
2. The Supreme Court has held that the recommendations of the GST Council are binding on the Union and the States.
3. In the GST Council, the Centre has one-third of the weighted votes and a decision requires three-fourths of the votes cast — giving the Centre an effective veto.
4. The GST compensation cess was discontinued in June 2022 when the five-year guarantee period ended.

Answer: (c). (a) is false — the share was retained at 41% despite 18 states demanding 50%. (b) inverts Mohit Minerals (2022), which held the Council's recommendations are recommendatory, not binding. (d) confuses two different things: the compensation guarantee ended in June 2022, but the cess itself was extended to 31 March 2026 — not to pay States, but to repay the ~₹2.7 lakh crore the Centre borrowed during COVID.

Mains practice questions

1. "The States get 41% of the divisible pool, but the Centre decides how big the pool is." Examine the role of cesses and surcharges in Indian fiscal federalism. (15 marks, 250 words — GS2)
2. "Article 282 is the back door through which the Union entered the State List." Critically examine the constitutional basis of Centrally Sponsored Schemes. (15 marks, 250 words — GS2)
3. States surrendered a permanent constitutional power in exchange for a five-year revenue guarantee. Critically evaluate GST from the standpoint of fiscal federalism. (15 marks, 250 words — GS2/GS3)
4. Evaluate the recommendations of the 16th Finance Commission. Does the new "Contribution to GDP" criterion undermine the equalisation principle? (15 marks, 250 words — GS2)
5. "Borrowing, not taxation, is the new front in India's fiscal federalism." Discuss with reference to Article 293 and the pending Kerala case. (10 marks, 150 words — GS2/GS3)

Conclusion

Financial relations look like the driest part of the Constitution. They are actually the most decisive. A State can have every legislative power on the State List and still be helpless if it cannot pay for anything.

And notice how the balance has shifted without a single word of Part XII being rewritten. Article 271, a technical surcharge clause, quietly decides what a 41% share is really worth. Article 282, a leftover grant power, now carries the entire Centrally Sponsored Scheme system into State List subjects. Article 293(3), unread by the Supreme Court for 74 years, has become the biggest question in Indian federalism. And Article 292's parliamentary limit on Union borrowing has simply never been enacted.

The text is federal. The practice is negotiated — every five years by a Finance Commission, every quarter by a GST Council, and every time a State asks permission to borrow. Learn the Articles, then learn where the real leverage sits. That gap is what the examiner is testing.

Frequently Asked Questions