Problems of Federal Finance:
In a unitary government, there is centralized public finance; but in a federation, two constitutionally independent physical systems operate upon the physical resources of the individual citizens.
There is a multiplicity of taxing and spending authorities in a federation. Thus, in a federation, the fiscal structure is decentralized, and wheels within the wheels operate in the financial machinery. Hence, it may be called multi-unit Public Finance. Thus, federal finance faces the problem of the “financial arrangement between the federal government and States. This is of crucial importance for them, for they govern the effective powers of the center and regions in the field of economic affairs and the nature of their future development.”
Thus, in a federal system, the functions and duties of the state are divided between the Central Government and several State Governments and they are generally defined in the Constitution. The allocation of function and resources between the Central and State Governments, however, differs from country to country. The general principle on which the allocation of functions and duties are based is “whatever concerns the nation as a whole, principally external relations and inter-regional activities should be placed under the control of the Central Government and that all matters which are primarily of regional rather than common interest should remain in the hands of the regional government.” It should, however, be noted that functions and duties should be allocated in such a way that each layer of the government gets those functions and duties which it is able to perform. In other words, the main criterion in the allocation of functions is whether a particular function can be best discharged by the Center or by the States, and the allocation should be made accordingly. Thus, following this principle, generally, external affairs, foreign and inter-regional trade, shipping, inter-regional communications, defense, post, and telegraph, etc. are assigned to the Central Government. Subjects of local interests such as education, health services, public works, social services, and internal law and order, etc., are assigned to the State Government. Broadly speaking, the functions which are of national importance have generally been assigned to the Central Government, and those which are of local or regional importance, have been assigned to the State Governments.
It should, however, be kept in mind that these functions can not be strictly separated in present times. There is no function in which both Central and State Governments are not interested. For instance, the Central Government is equally interested in developmental functions like education, public health, etc. Similarly, State Governments can not ignore defense, communication, etc. Thus, there should be close coordination between the policies of the Central Government and State Governments. In any case, the interests of the Central Government should not come in conflict with State Governments. Thus, James A. Maxwell rightly said that “the practice of cooperative federalism does not correspond to the theory of separation of functions.” Here, he also quotes, Morton Gordzins saying that “colors are mixed in marble cake, so functions are in the federal system.”
Allocation of functions may create problems in the allocation of resources between Central and State Governments corresponding to their requirements. Therefore, “the fundamental problem of federal finance is ensuring that the division of revenue between Central and Regional Governments correspond with the distribution of function in order that each government may have the functional capacity to carry out its responsibilities as far as possible.” This is a difficult problem that generally arises, in a federal setup. It is not easy to allocate functions between Federal and State Governments and when they are allocated, it is still more harder to allocate resources between them, because both functions and the responsibilities for financing them overlap. Besides, functions and responsibilities are dynamic in character. For instance, the responsibilities of the State Government may be comparatively less fifty years back than what they are at present. Accordingly, the financial requirements of the State may be less at that time than what they are at present. And the same may be true for the Central Government. Thus, the success of Federal Finance depends upon the efficient solution of these problems and adjusting it with changing circumstances.