A detailed data analysis published in The Hindu, based on a new handbook titled Realising Rights prepared by the Centre for the Study of the Indian Economy at Azim Premji University, reveals a structural imbalance in India’s fiscal federalism: while tax revenues disproportionately accrue to the Union government, the responsibility for funding welfare schemes falls increasingly on fiscally constrained States. This finding has significant implications for Centre-State relations, the sustainability of India’s welfare architecture, and the broader debate on cooperative versus competitive federalism.
According to the data, combined allocations for major welfare schemes in 2025-26 amounted to ₹24.20 lakh crore, or 6.77% of GDP, but the Union government’s contribution accounted for a mere 1.89% of GDP, with States shouldering the remainder. This divergence has widened over the last decade, even as India’s welfare regime shifted definitively from a rights-based framework — established through legislations passed in the 2000s — towards a cash-transfer-oriented model.
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For UPSC aspirants, this topic offers a rich opportunity to examine the interplay between fiscal federalism, the Finance Commission’s recommendations, cooperative federalism under the Indian Constitution, and the practical politics of welfare delivery — themes central to both GS-II (Governance) and GS-III (Economy).
Background and Context
India’s constitutional design under the Seventh Schedule assigns major taxation powers to the Union while placing significant welfare and social sector responsibilities, such as school education and public health, primarily on States. This asymmetry has been partially addressed through devolution mechanisms recommended by successive Finance Commissions, but the growing scale of centrally sponsored schemes with rising State co-funding requirements has intensified fiscal stress on state exchequers.
Five Important Key Points
- States’ share of school education spending stands at 75.2%, while health expenditure obligations are similarly skewed towards State budgets, according to Reserve Bank of India data on State Finances.
- The replacement of the fully Centre-funded MGNREGA (funded in a 90:10 ratio) with the new Viksit Bharat-Guarantee for Rozgar and Ajeevika Mission (VB-G RAM G), which requires States to bear 10% of costs, adds a fresh financial burden on states such as Himachal Pradesh.
- Real government expenditure on social services has increased substantially over time, but the Union government’s proportional contribution has remained largely stagnant, meaning the overall rise has been driven predominantly by States.
- India’s tax-to-GDP ratio, while comparable to middle-income countries, lags significantly behind in social security spending as a share of GDP.
- Centrally sponsored schemes like PMMVY (Maternity Entitlements) and ICDS operate on a 60:40 Centre-State funding ratio, further compounding the fiscal load on state governments already facing constrained resources.
Constitutional and Legislative Framework
Article 280 of the Constitution establishes the Finance Commission, tasked with recommending the distribution of tax revenues between the Union and the States. The Sixteenth Finance Commission’s reports, cited extensively in the data analysis, reveal that States spent ₹4.14 lakh crore on unconditional cash transfers, a figure that dwarfs Union spending on comparable schemes such as PM-KISAN and the National Social Assistance Programme (NSAP). This constitutional mechanism, while designed to correct vertical fiscal imbalance, has proven insufficient to match the pace at which welfare obligations have devolved onto States.
From Rights-Based Welfare to Cash Transfers
A crucial historical shift underlies this crisis. In the 2000s, India enacted a series of rights-based welfare laws — the Right to Education Act, the National Food Security Act, and MGNREGA among them — establishing statutory entitlements. Over the past decade, however, policy emphasis has moved towards direct cash transfers, which, while administratively simpler, often lack the same legal enforceability and long-term fiscal predictability for States implementing them.
Bihar’s Fiscal Federalism Challenge
Bihar exemplifies the structural vulnerability described in this analysis. As one of India’s most fiscally constrained States with a comparatively low own-tax revenue base, Bihar depends heavily on Central transfers and devolution to fund welfare schemes in education, health, and rural employment. Any increase in State co-funding obligations — as seen with the MGNREGA replacement scheme — disproportionately affects Bihar’s capacity to sustain welfare delivery, given its lower per capita fiscal space compared to more industrialised States. This makes Bihar a critical stakeholder in debates over greater devolution and predictable, formula-based Central assistance rather than scheme-specific co-funding mandates.
Economic Implications
The growing mismatch between revenue collection and expenditure responsibility has several implications: it constrains States’ fiscal space for capital expenditure, increases dependence on market borrowings, and creates incentives for States to under-invest in welfare during periods of fiscal stress. It also complicates macroeconomic coordination, since States collectively account for the majority of general government expenditure but have limited influence over overall fiscal policy direction, which remains Union-dominated through instruments like GST Council decisions and centrally sponsored scheme design.
Governance Concerns
The current model raises accountability concerns: when a scheme fails or under-delivers, the political blame often falls on the implementing State government, even though scheme design, funding pattern, and eligibility criteria are frequently set by the Union government. This asymmetry between political accountability and fiscal control weakens the coherence of cooperative federalism envisaged under the Constitution.
Way Forward
The Union government must reconsider co-funding formulas for major welfare schemes, particularly for fiscally weaker States, potentially adopting a differentiated funding pattern based on a State’s fiscal capacity index. Strengthening the Finance Commission’s mandate to explicitly account for welfare expenditure obligations while determining devolution shares would help correct the imbalance. Additionally, moving towards predictable multi-year funding commitments rather than annual budgetary allocations would allow States to plan welfare delivery with greater fiscal certainty.
Relevance for UPSC and SSC Examinations
This topic is highly relevant for UPSC GS-III (Indian Economy, government budgeting, fiscal federalism) and GS-II (Centre-State relations, Finance Commission). Aspirants should remember: Article 280 (Finance Commission), Sixteenth Finance Commission, MGNREGA vs VB-G RAM G, PMMVY, ICDS, PM-KISAN, NSAP, and the 60:40/90:10 funding ratios used in centrally sponsored schemes.