Principles of Federal Finance

Principles of Federal Finance:

Prof. B. P. Adarkar, in his celebrated book on Principles and Problems of Federal Finance, lays down three principles that should govern the working of the Federal Finance System. These principles have been discussed as follows:

(1) Independence and Responsibility- In the first place Professor B. P. Adarkar said that “full freedom of financial operations must be extended to both federal as well as State Governments in order that they may not suffer from a feeling of cramp in the discharge of their normal activities and in the achievement of their legitimate aspirations for the promotion of social and economic advancement.” It means that Central and State Governments must each have under it, its own independent Central Financial resources sufficient to carry out its exclusive functions. In other words, Central and State Governments should be financially independent within their own sphere. Besides, each government should take the responsibility of taxing, borrowing, and raising resources in their spheres for performing their functions. The authority, which has a pleasing job of spending money, should also do the unpleasant job of raising it. Thus, “taxing autonomy and spending autonomy should go hand-in-hand.”

However, there are some who believe that, if every level of government is to raise the money that it was going to spend, then there would be a great disparity in quality and quantity of public expenditure from State to State. States with wealthier populations and richer tax resources will be able to fulfill their social obligation much better than the poor ones.  In an underdeveloped country, certain practical considerations make it difficult to follow the principle of financial independence. Considerations such as uniformity in tax rates throughout the federation, promotion of economic growth and maintenance of internal and external stability, and balancing economic and social development in all regions, etc., cannot be ignored. In other words, the advocates of this view intend that taxing autonomy should lie with the Federal Government while spending autonomy with the states.

Theoretically speaking the case of centralization of revenues in the hands of the Federal Government appears to be very sound in the case of underdeveloped countries on the ground of economy and efficiency and balanced economic growth.

However, the practical point of view should not be totally ignored. If too much dependence of the State Government on the Central Government for finance is accepted then the former may be reduced to the status of spending agencies of the Federal Government and may not feel like partners in progress. It is, therefore, concluded that Central Government and State Governments both should be autonomous in the sphere of raising resources and performing their functions effectively, but a periodical adjustment in these aspects is necessary for the successful working of both governments.

(2) Adequacy and Elasticity- The principle of adequacy means that the resources of Central and State Governments should be adequate so that each layer of government can discharge its obligations laid upon it. It stands for the sufficiency of resources for the discharge of functions and duties assigned. Thus, Sir John Latham, former Chief Justice of the Australian High Court said, “If a federal system have financial resources under their own control reasonably adequate to meet their responsibilities.”

Besides, adequacy, there should be elasticity in the financial resources. It means that resources should be capable of expansion in response to the rapidly growing needs and responsibilities of the government concerned. Otherwise, the Federal Finance Scheme will become an obstacle in times of economic and defense crises. For this, each layer should have considerable initiative and freedom to raise finance.

(3) Administrative Economy and Efficiency- For the success of Central-State Financial Realtions, it is very much required that the administrative cost should be minimum and there should be no fraud and evasion in matters of finances. It should also be taken into account that at the time of allocating resources as to whether a certain source can be better administered by the Federal or State Government. Corruption and inter-regional smuggling are to be avoided and the sources of revenue are to be fully exploited.

Some Other Principles:

Besides these principles, some scholars on the subject of Central-State Financial Realtions have added a few more principles in view of the needs and present conditions, especially of underdeveloped countries.

(4) Principle of Equity- Equity is an important cannon of taxation laid down by Adam Smith. The applicability of this principle in the Federal System is important because, in the assignment and allocation of functions, there is an opportunity for inequity to creep in and may spoil the entire structure. Different States of a Federation may have disparities in the level of economic development, and therefore, according to this principle, the burden of taxation will be inequally distributed as the marginal sacrifice will be different in different states. The marginal sacrifice of the taxpayers of richer States will be less as compared to those of the poor states. Therefore, a need may arise to adjust the Federal and State taxes in such a way that the marginal sacrifice of the Federal and State taxation taken together is equal or nearly equal to every person, no matter in which State he resides. Therefore, there should be a proper adjustment between Federal and State taxation so as to make the tax burden on all citizens equitable as far as possible.

(5) Principle of Integration and Coordination- The whole financial system of a federation should be well integrated and each layer of the financial system of the federation should not be taken as completely isolated from the other layers of the financial system. Integration of financial systems of federal and State Governments is essential in contemporary federations. This should be done in a way that promotes economic development. Coordination is also important for the smooth and efficient working of the Federal Financial system. The coordination of the federal State should not be in taxation alone but in every aspect of finance. “The coordination of Federal State and local finance should, however, be concerned not only within taxation. It should also embrace the current budgets, capital outlay programmes, and credit operations of various authorities and should be accompanied by coordination of administrative activities as well.

(6) Principles of Accountability- Freedom and democracy are sister institutions in a federal system. Therefore, in a federal system such government should be accountable to its own legislature for its having and spending decision and should make these decisions with due regard for their effect on other governments.

(7) Principle of Uniformity- The financial system in a federation should be such as to enable each Regional Government to provide an adequate level of public service without resorting to higher rates of taxation substantially than those of other regions.

(8) Principle of Fiscal Assess- There should be no bar on Central and State Governments in developing new sources of revenue within their own prescribed fields to meet the growing financial needs. It implies that resources should grow with the increase in responsibilities.

The problem of federal finance should not be overshadowed by dogmas or rigid principles but should be solved by an approach of reality and pragmatism, so that healthy financial relations may develop. The conditions differ from time to time and therefore a fixed division of financial resources cannot be applied. Thus, the division of resources should be subjected to flexibility and adaptability. There can be no final solution to the allocation of financial resources in a federal system. There can be only adjustments and reallocation in light of changing conditions. Thus, rigidity should be replaced by dynamism, and changes be made according to the needs of different layers of the government. “The importance of flexibility or adaptability in the distribution has been widely recognized.” Flexibility seems to be a sine-qua-non of a rational system of federal finance. According to Dr. Gyan Chand, the system of federal finance should be designed to meet the needs of changes that may have to be introduced in the interest of harmony and efficiency. It should be based on a large measure of general consent. It can, however, be concluded that Central and State Governments should collaborate in such as way that ensures maximum utilization of natural resources, accelerated economic development, reduction in disparity, and augmentation in production and productivity.

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