Union Budget 2026: How Fiscal Allocations Are Reshaping Centre–State Relations

State–Union financial relations have always been politically fraught, rooted in a long-standing resistance to the Union government’s centralising tendencies. Repeated confrontations between states and the union government over fiscal devolution are not new. What is new is the sharp escalation of these disputes, with some state governments now alleging that financial decisions are being driven by ideological considerations. Kerala, Tamil Nadu and West Bengal have, over the years, mounted sustained challenges to defend the limited fiscal autonomy available to states. How did this conflict deepen to its present intensity?

Net borrowing ceilings, the end of GST compensation, and the linking of fund releases to the implementation of centrally sponsored schemes have emerged as major flashpoints for states such as Kerala and Tamil Nadu. Both states argue that these measures disproportionately affect them, given their long-standing commitments to welfare spending and social-sector investments. The tension has been further heightened by the Union government’s decision to redefine state debt to include borrowings by state-owned enterprises within the overall borrowing limit. Kerala contends that this move has severely constricted its fiscal space.

Kerala has demanded a Special Fiscal Correction Package of Rs 21,000 to rectify what it describes as a severe fiscal setback caused by cut in its borrowing limit. Kerala has also reiterated its demand that the Central share under Centrally Sponsored Schemes (CSS) be increased from 60 per cent to 75 per cent.

Centrally sponsored schemes are designed by the Union government but implemented by the states, with the Centre typically bearing only 60 per cent of the expenditure and leaving the remaining 40 per cent to be funded by state governments. States have long argued that such schemes are imposed without adequate consultation and have demanded a higher central share to ease their fiscal burden.

In 2023, Kerala approached the Supreme Court, accusing the Union government of arbitrarily imposing a Net Borrowing Ceiling (NBC) that, the state argued, pushed it to the brink of a financial crisis and severely restricted its ability to meet basic obligations such as salary and pension payments. The court referred the suit to a Constitution Bench to interpret the scope of Article 293 of the Constitution, specifically to determine whether a state enjoys an “enforceable right” to raise its borrowing limits beyond the cap fixed by the Union government. The verdict is expected to have far-reaching consequences for fiscal federalism in the country.

At present, the NBC for states is capped at three per cent of the Gross State Domestic Product (GSDP). State governments ruled by opposition parties have been demanding the preservation of constitutionally safeguarded state autonomy to manage their own fiscal priorities, including borrowing.

Opposition-ruled states have alleged that the Union government is imposing increasingly stringent conditions on centrally sponsored schemes, aggravating their fiscal stress. Illustrating this trend, economist and Kerala State Planning Board member K. Raviraman highlights a consistent decline in central transfers to Kerala in recent years. According to official figures, central funds to the state fell from Rs 47,837.21 crore in 2021–22 to Rs 45,368.24 crore in 2022–23, before dropping sharply to Rs 38,811.24 crore in 2023–24. In proportional terms, the Centre’s contribution to Kerala’s total receipts has declined from about 34 per cent to nearly 25 per cent over a four-year period.

Economists note that similar patterns are visible in other opposition-ruled states, where the share of untied transfers from the Centre has declined even as states’ expenditure commitments—particularly on welfare, health and salaries—have continued to rise, intensifying concerns over the erosion of fiscal federalism.

Opposition-ruled states have alleged that the Union government’s conditions on centrally sponsored schemes and transfers are significantly undermining their fiscal positions. Evidence from allocations and actual transfers shows distinct patterns that reinforce those concerns.

According to a reply in the Lok Sabha, Union Education Minister Dharmendra Pradhan stated that Rs1,160.52 crore is due to Kerala under the Samagra Shiksha scheme for the last four years, underscoring the state’s claim of pending central releases under key centrally sponsored programmes.

Actual central funding under specific schemes also reveals disparities. Under the Samagra Shiksha scheme for 2024–25, Kerala was allotted Rs 328.90 crore, Tamil Nadu, Rs 2,151.60 crore and West Bengal Rs1,745.80 crore, none of these state had received any funds from the Centre as of late March 2025, even as other states received large disbursements ( Uttar Pradesh had received Rs 4,487.46 crore of its Rs 6,971.26 crore allocation) — highlighting inequalities in fund releases.

State-wise data on centrally sponsored scheme transfers also show variation: Kerala’s CSS transfers fell from Rs 8,299.85 crore in 2021–22 to Rs 8,061.35 crore in 2023–24; West Bengal’s fell more sharply, from Rs 18,545.33 crore to Rs 11,386.27 crore over the same period.

The Centre has insisted that the National Education Policy (NEP) and the PM-SHRI project be implemented as a precondition for the release of central funds. Tamil Nadu has opposed this move, citing its long-standing resistance to the three-language policy under the NEP. Kerala, meanwhile, has refused to implement the PM-SHRI scheme, arguing that the project carries an ideological tilt aligned with Hindutva.

Taken together, these data points suggest that opposition-ruled states like Kerala, Tamil Nadu, and West Bengal not only receive smaller shares of formula-based tax devolution but also face volatility and delays in specific scheme transfers, compounding their fiscal challenges. Economists argue that these trends, when viewed alongside restrictions such as net borrowing ceilings, underscore deeper structural tensions in India’s fiscal federalism.

Kerala and Tamil Nadu have consistently mounted political pressure on the Union government, accusing it of adopting a politically motivated approach towards opposition-ruled states. In 2024, the Left Democratic Front government in Kerala, under Chief Minister Pinarayi Vijayan, organised a protest march at Jantar Mantar in New Delhi, drawing participation from several opposition-ruled states and foregrounding concerns over fiscal discrimination.

In Tamil Nadu, the issue has also taken on a sharper political edge. During Prime Minister Narendra Modi’s visit to the state last week, social media platforms were abuzz with calls demanding the release of pending central funds. Chief Minister M.K. Stalin led the campaign, questioning when Tamil Nadu would receive the Rs3,458 crore pending under the Samagra Shiksha education scheme.

As the Union Budget is presented and three opposition-ruled states head to Assembly elections within the next three months, Centre–State relations—and the politics shaping them—are set to come under renewed scrutiny during and after the budget exercise