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In the federal finance, we have to study the economic relations between different
layers of government. So a new guiding principle has to be laid to allocate the
different functions for different layers of the government. The main principle of
determining the financial policy of a federal set up is under noted :


Different sources of public revenue can be handled in the best way at the different
levels of the governing bodies (union government, state government and local
government) in such a way so as to ensure the maximum efficiency in the collection of
public revenue. The nature of certain revenue is national in character while some type
of revenues can be allocated on the regional or local basis, e.g. income-tax is collected
by the Government of India if it were collected by the states then there would have
been a great anomaly because of diversity of tax rates and varied degree of exemption.
The union government is empowered to collect all these taxes of its own. On the other
hand, the taxes of local origin like land tax, electricity duty, water chargcs can be
collected by state government in an efficient manner. This also saves from the


The union government should perform its responsibility in such a manner that all
states in a federal set up get uniform treatment. In the tax policy, no state should be
put with higher burden of tax and no state should be discriminated for the grant-in-aid
or benefits provided to them. The term uniformity means that the system of taxation
and pattern of expenditure should be same irrespective of the state. It means that a
commodity should be taxed at the same rate, at the same line except some special
circumstances. However, financial uniformity does not mean that equal amount is paid
by states to the centre but it means that the contribution made by the different states to
the central government should be in accordance with the economic situation of the
state concerned.


Another principle of allocation of resources between centre and state is the principle
of economy. It means that tax collecting system should be based on economy. The
collection of tax revenue is so designed that it should have least expense for the
purpose and the scope of evasion of tax is minimised. The administrative delay should
also be the least.



Under the federal set up, the government should be free to operate in the internal
financial matters and it should have its own adequate sources of revenue and scope of
expenditure. The state government should not look towards other state government for
financial help. Each government should be independent to raise its own resources and
spend it according to its own choice. Here it should be remembered that autonomy
does not imply that a state government has nothing to do with the union government
in the federal set up. But the state government is free of control of union government
in the case of income and spending. The centre should hesitate to interfere with the
function of the states which come strictly under the preview of state governments. The
state government, on the other hand, should not interfere with the central government
so far as their functions are concerned. It is only possible when there is complete
understanding between these two layers of government and their spheres of operations
are pre-determined.


In a federal set up, the provision regarding the allocation of financial resources
between union government and state government should be based on the principle of
self-sufficiency of fiscal competence. The financial powers should be so demarcated
among different layers of the government that there adequate revenue available with
both governments to perform their functions efficiently. If the revenue is not sufficient
it will hamper the ability of administration of the particular layers of government. It
will also result in instability and stagnation.


The principle of the federal system should be flexible enough to meet the fast
changing requirements of the economy. The allocation of financial n sources between
different layers of the government should not only be on the l>imi iple of fiscal
competence or self-sufficiency but also possess flexibility which may change with the
passage of time. These provisions should ensure elasticity in i lie finance of the states
as well as the union government.

Economic Regulations

The financial resources should be allocated in such a manner that the economic
system of the federal set up remains stable as a whole. The taxation policy should not
be based only on the additional resources mobilisation but it should also consider
inflation and deflation, rate of growth and other economic disparities between
different sections of the society.


Transfer of Resources

Another principle of allocation of resources between centre and state government is

that there be a provision to transfer the resources from one state to the other.
Generally, it is observed that some states are rich while other face the scarcity of
resources. So, it requires simultaneous division of resources.

Adequacy and Elasticity

The allocation of resources between the central government and state government
should be adequate so that each layer of government may be capable to discharge its
responsibilities and obligation in a proper manner. Besides adequancy, it must possess
the quality of elasticity in the financial resources. It means that there must be
feasibility to expand its resource in response to its requirements especially during the
period of economic and defence crisis. Financial allocation must have an element of
elasticity so that central government and state government may be able to obtain more
income to face the crisis or emergencies boldly.

Integration and Co-ordination

Integration and co-ordination is essential in the distribution of resources between twolayer governments as it leads to promote economic development in a federal system.
The co-ordination is not required in the matter of taxation only but also in every
sphere of the financial activities. The coordination of fiscal state and local finance
should, however, be concerned not only with taxation. It should also embrace the
current budgets, capital outlay programmes and credit operations of various
authorities and should be accompanied with a co-ordination of administrative
activities as well.


According to Seligmans another principle of federal finance is suitability. A tax may

have wider or narrower jurisdiction. Taxes with narrow jurisdiction cannot be suitable
to the central government. Similarly, taxes with wide jurisdiction will not be suitable
to local governments. Thus, whether a tax should belong to the states or to the centre
should be determined by the width of the tax base. For example, real estate tax which
has a narrow base should belong to the local authorities.