White Paper on Indian States (1950)/Part 9/Recommendations of the Committee

by Ministry of States, Government of India

Recommendations of the Committee

189. The fundamental basis of the Committee's approach was that financial integration must necessarily be viewed as merely an essential part of the general federal integration of India resulting from the fact that under the "Objectives" Resolution of the Constituent Assembly the Provinces and the States alike would be equal partners in the Union of India.

From this concept of States and Provinces as equal partners' it follows that the Central Government should function in States over the same range of subjects and with the same powers as in Provinces. It is only in this way that the Union of India will gain in strength and its policies in effectiveness. There is no Federation in which the Central Government possesses different levels of power and authority in the units comprised in it. Such differences in jurisdiction from unit to unit are bound to be a source of weakness and to produce a sense of unfairness among the less favoured units which will be fatal to friendly relations and orderly progress.

The Committee therefore rightly conceived federal financial integration "as a necessary consequence of the basic conception underlying the new Constitution of the Union of India," and this clearly involved that the whole project should be grounded upon the following propositions:—

"Federal Financial Integration must be based upon complete equality between Provinces and States in the following respects:—

(1) the Central Government should perform the same functions and exercise the same powers in States as in Provinces;

(2) the Central Government should function through its own executive organisations in States as in Provinces;

(3) there should be uniformity and equality in the basis of contributions to Central resources from Provinces and States;

(4) there should be equality of treatment as between Provinces and States in the matter of common services rendered by the Central Government, and as regards the sharing of divisible federal taxes, grants-in-aids, "subsidies", and all other forms of financial and technical assistance."

These propositions have been accepted without reserve by all States; but in the course of subsequent negotiations the representatives of some of the Unions urged—and the Government of India readily accepted—the inclusion of the following further proposition:

"There is need for assistance to Unions of States in connection with the internal integration of their administrations and services, and particularly in relation to their development in various directions in view of the undisputed fact that they are in a state of considerable backwardness compared with Provinces. Government of India must, therefore, undertake a systematic enquiry into this problem with a view to rendering financial and technical assistance at the earliest opportunity; it will not be enough merely to say that as a result of federal financial integration, they will be treated in the matter of grants and other forms of assistance in exactly the same way as Provinces".

190. With these as the basic conceptions, the Committee proceeded to a consideration of the practical consequences of federal financial integration. In the words of the Committee:

"Federal integration………essentially involves a two-fold process,—one of "functional partition" of the present 'composite' State Governments; and the other of 'merger' of the partitioned 'federal' portions of the State Governments (together with the revenues, assets, liabilities and functions appropriate thereto^[1]), with the present Central Government in India (together with its corresponding resources), to constitute a new Government of the Union of India."^[2]

Consequently—

"(a) All present and future revenues from "federal" sources and all expenditure on functions and services of a 'federal' character, together with all assets and liabilities connected therewith, must be transferred from the States to the Centre; so, too, the administration of all these Departments. And all internal trade barriers must be abolished.

(b) Subject to a measure of gradualness in certain directions as regards the full effect of its impact, federal financial integration should be complete in all respects from the outset."^[3]

On the question of compensation to the States for their federal revenues and assets passing to the Centre, the Committee was equally clear. Its recommendation was as follows:—

"30. A general question which arises in this connection at the very outset and to which we have devoted much attention and we have also discussed with the Governments concerned, is whether, upon the integration of their present "federal" functions and finances with those of the Union of India, States are entitled to "compensation", in the form of payment of market value or capital invested according to accounts, for the "federal" assets transferred to the Central Government. The most important of these assets are the Railway systems in States.

"We have no doubt whatever that the question of compensation in this form does not arise and cannot be raised.

"We shall first take the case of a State like Baroda, which is being "merged" in the Bombay Province. The constitutional position here is that the Ruler of Baroda, by agreement with the Dominion Government, cedes to the Dominion "full and exclusive authority and jurisdiction and powers for and in relation to the governance of the State". The Dominion Government thereupon takes over all the "federal" or "Central" functions appertaining thereto and by an order under Section 290A of the Government of India Act, 1935, as adapted by the India (Provisional Constitution) Order, 1947, directs that Baroda State "shall be administered in all respects as if the State formed part" of the Governor's Province of Bombay. When such an order is made the Government of Bombay assumes only the "Provincial" functions in the area, with all the revenues, assets and liabilities appertaining thereto. It is obvious that there can be no question in this case of the Government of India paying compensation to the Bombay Government for any federal assets.

"Essentially similar is the case in respect of States which retain their individuality. Like Baroda, before its "merger", they now have "composite" Governments, comprised of two functional entities—one with "federal" functions and the other "provincial" functions. Complete "federal integration" means a "functional" bifurcation, the "federal" portions of the State Governments are to become integrated with the Government of the Union of India, leaving behind "provincial" State Governments with purely "provincial functions". There can, therefore, be no question of the revenues of the Union of India paying compensation of the nature indicated, to the "provincial" section of the States Governments, when the Railways and other services, which are to be "federally" administered for the benefit of the people in these areas, are taken over by the Union Government of India.

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"Fundamentally, it is not a case of the present Government of "British India" purchasing the Railways of "Indian States" as a commercial investment for the benefit of "British India". What is involved is a process of pooling together the "federal" resources of the people of the States with the "federal" resources of the people of "British India"; the result is a merger of the "federal" resources of the people of India as a whole,—that is, of the States and of "British India" alike—for administration, in the interests of all, by a new Central Government of the Union of India whose "power and authority" (together with the wherewithal for their exercise), are derived from all the Units. In the circumstances no question of payment of "compensation" can obviously arise.

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"We consider, therefore that except for certain necessary financial adjustments (concerning the equitable apportionment of the States' liabilities between them and the Centre) no "compensation" as such should be paid tor any assets passing to the Centre as a result of the integration of the federal finances of the States with those of the rest of India.

"31. We are equally clear that no similar question of "compensation" arises in connection with the integration of such "federal" revenues of the States as Customs duties on foreign trade, Central Excise Duties, Income-tax and the like.

"We recognise, of course, that the integration of all "federal" revenues of States with those of the Centre will give rise to maladjustments in their financial position; and the remedy for this lies in ascertaining the precise extent of the net over-all dislocation likely to be caused, and then providing necessary financial (revenue) adjustments between the Centre and the States, over such transitional period as may be permitted by the Union Constitution……… so as to avoid such dislocation."^[4]

191. These constituted the governing principles of federal financial integration when the matter was approached from the point of view of the. Federation. Looked at from the point of view of the States, however it involved some very difficult administrative and financial problems. In the first place, there was the sheer administrative problem of bringing about such a large scale merger of functions, resources and personnel at the federal level; next there was the problem of equitable allocation and apportionment of liabilities; and finally, there was the need to evolve certain transitional financial adjustments such as would avoid any sudden financial dislocation in the States. The Committee fully realised the magnitude of these difficulties and the necessity to find adequate solutions for them.

(1) The Committee's recommendations concerning the administrative problem need not be referred to here. Its various aspects—legislative, executive and "personnel"—are under separate examination, in consultation with the States and with the various Ministries of the Government of India.

(2) In regard to the equitable allocation and apportionment of the liabilities of the States between them and the Centre, the Committee's detailed recommendations are contained in Chapter III of Part II of its Report; and their actual working has been illustrated in the subsequent chapters which contain the integration schemes for individual States. As an example, Section B of the Mysore Scheme (in Chapter IV at p. 31 of Part II of the Committee's Report) may be referred to. These recommendations resulted from certain basic principles, set out at p. 21 of Part I of the Committee's Report, viz:—

"(i) that the Centre should also take over all public debts specifically incurred in connection with (federal) assets;

(ii) that where the public debt of a State is not specifically earmarked as incurred for individual capital assets, it should be distributed between the Centre and the State in proportion to the "federal" and "provincial" productive capital assets;

(iii) that where, apart from public debt, these is in any State, an excess of current liabilities over liquid assets, such excess should also be distributed between the Centre and the State in the same proportion as above; and

(iv) that, to the extent that the loss of revenue from those assets . . . . is likely to cause sudden dislocation of the finances of any State, the problem will be one of necessary financial adjustments on revenue account between such State and the Centre, i.e., should form part of the over-all problem of the financial consequences of the integration to be dealt with under item (4) of our Terms of Reference."

(3) Finally, as regards transitional financial adjustments required on revenue account and the need for gradualness in the process of financial integration, so as to avoid any sudden dislocation of the finances of the States, the Committee recommended as follows [paragraph 2(c) of Part II of its Report]:—

"(i) the abolition of internal customs duties in one or two States may be spread over three to five years; in all other States these duties should be abolished as soon as financial integration becomes effective;

(ii) the rates of Income-tax in States should be raised to the level of Indian rates in two or three stages;

(iii) the administrative transfer of certain 'federal' functions and services to the Centre may be effected gradually;

(iv) the transfer of the net 'burden' of financial integration to the States (or the Centre) must be gradual; it should take the form of appropriate financial adjustments between the Centre and the States, extending over such transitional period,—ten years, or fifteen,—as may be provided in Article 258^[5] of the Draft Constitution; and these adjustments should be so devised as to cause no sudden dislocation of the finances of States or of the Centre at the commencement of financial integration, or during (or at close of) the transition period.

The foregoing recommendations and the action taken thereon are explained in the succeeding paragraphs.

1. List I of the seventh Schedule to the Constitution of India.
2. Page 20, Part I of Committee's Report.
3. Pages 1-2, Part II of the Committee's Report.
4. Part I—Pages 19 to 21 of the Committee's Report.
5. Article 278 of the Constitution as finally adopted.