BLS LLB 5 Years Sem 1 Economics February 2026 Question Paper with Solutions

Definition

Economics is the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses.
(Lionel Robbins, An Essay on the Nature and Significance of Economic Science, 1932)

The definition rests on four elements: unlimited ends, scarce means, alternative uses of those means, and the necessity of choice. An earlier definition by Alfred Marshall (Principles of Economics, 1890) described economics as a study of mankind in the ordinary business of life.

Relevance to law

1. Both subjects deal with scarcity. Economics explains how scarce resources are allocated. Law creates and enforces the rights which make that allocation binding, so the law of property and the law of contract are allocation rules in legal form.

Meaning

Microeconomics studies individual economic units such as a single consumer, a single firm or a single market. It is called price theory.

Macroeconomics studies the economy as a whole through aggregates such as national income, the general price level and total employment. It is called income theory.

Both terms were coined by Ragnar Frisch in 1933.

Difference

Meaning

Oligopoly is a market structure in which a few large sellers supply the whole or the greater part of the output of an industry, and each seller is large enough to influence the market price.

Features

1. Few sellers and many buyers.
2. Interdependence. Each firm must consider how its rivals will react before it changes price or output. This is the chief feature of oligopoly.
3. Barriers to entry such as heavy capital requirement, licences, patents or spectrum.
4. Nature of product. It may be homogeneous, as in cement and steel, or differentiated, as in cars and telecom services.
5. Price rigidity. Prices remain unchanged for long periods. Paul Sweezy explained this by the kinked demand curve: rivals match a price cut but ignore a price rise.

Meaning

MSMEs are Micro, Small and Medium Enterprises, classified under the Micro, Small and Medium Enterprises Development (MSMED) Act 2006. Classification is made on a composite criterion of investment in plant, machinery or equipment together with annual turnover. An enterprise must satisfy both limits, and since 1 July 2020 there is no separate treatment for manufacturing and service enterprises.

Limits in force

Revised by Notification S.O. 1364(E) dated 21 March 2025, effective 1 April 2025.

Two important features

Meaning

Cross elasticity of demand measures the responsiveness of the quantity demanded of one good to a change in the price of another good.

Formula

Exy = Percentage change in quantity demanded of X / Percentage change in price of Y

Types

1. Positive cross elasticity: substitutes. A rise in the price of Y increases the demand for X. Example: tea and coffee.
2. Negative cross elasticity: complements. A rise in the price of Y reduces the demand for X. Example: cars and petrol.
3. Zero cross elasticity: unrelated goods. Example: salt and laptops.

The law of demand

Other things remaining equal, a rise in the price of a commodity reduces the quantity demanded and a fall in price increases it. Price and quantity demanded move in opposite directions.

Exceptions

1. Giffen goods. Named after Sir Robert Giffen. These are strongly inferior staples on which poor households spend a large part of their income. A rise in price cuts real income so much that the household gives up the costlier substitute and buys more of the cheap staple. Example: coarse cereals such as bajra and jowar.
2. Veblen goods, or conspicuous goods. Thorstein Veblen showed that some goods are bought for the prestige of a high price, so demand rises as price rises. Example: diamonds, luxury cars, designer handbags.
3. Expectation of a further rise in price. If buyers expect prices to rise further they buy more at the present higher price. Example: gold before an expected increase in duty.

Meaning

The balance of payments is a systematic record of all economic transactions between the residents of a country and the rest of the world during a given period, usually one financial year. In India it is compiled and published by the Reserve Bank of India.

Structure

1. Current account. Trade in goods, called visibles. Trade in services, called invisibles, such as software and travel. Primary income, being interest, profit and dividends. Secondary income, chiefly private remittances.
2. Capital and financial account. Foreign direct investment, foreign portfolio investment, external commercial borrowings, loans and banking capital.
3. Errors and omissions, a balancing entry for statistical gaps.
4. Change in foreign exchange reserves, through which the overall balance is settled.

Important points

Meaning

Commercial policy, also called trade policy or foreign trade policy, is the set of government measures which regulate a country's trade with the rest of the world, covering both exports and imports.

Instruments

1. Tariffs, that is customs duties on imports.
2. Quotas and other quantitative restrictions.
3. Import and export licensing.
4. Export promotion through subsidies, duty drawback and tax incentives.
5. Exchange control.
6. Anti dumping and countervailing duties.
7. Non tariff barriers such as quality, packaging and standards requirements.
8. Trade agreements, both bilateral and multilateral.

Objectives

1. To protect infant and domestic industry.

3. Regional Councils, convened for issues affecting more than one State.
4. Vice Chairperson, full time members, part time members, and up to four Union Ministers as ex officio members.
5. Chief Executive Officer of the rank of Secretary, appointed by the Prime Minister.

Features

1. Advisory body. It is a think tank and does not allocate funds to States. That power rests with the Ministry of Finance.
2. Bottom up planning. States frame their own priorities and NITI Aayog supports them, an approach it calls cooperative federalism.
3. No Five Year Plans. The Twelfth Plan (2012 to 2017) was the last. In their place are a fifteen year Vision, a seven year Strategy and a three year Action Agenda.
4. States as equal partners rather than applicants for central funds.
5. Knowledge and innovation hub, not a controlling authority.

Functions

Criticism

Because it neither allocates funds nor issues binding directions, NITI Aayog depends entirely on persuasion, which critics say leaves it weaker than the body it replaced.

Conclusion

The trade-off was deliberate. The Planning Commission's control over plan funds was exactly what made central planning coercive, and transferring the money to the Finance Ministry restored the constitutional position, in which transfers to States flow through the Finance Commission under Article 280.

1. Expansion or prosperity. Output, employment, income and investment rise together. Credit expands, capacity utilisation climbs and business expectations are optimistic.
2. Peak or boom. Activity reaches its maximum. Capacity is fully used, so further demand raises costs rather than output. Bottlenecks appear, inflation accelerates and over-investment builds up. This is the upper turning point.
3. Contraction or recession. Demand falls, output and employment shrink, investment is postponed and profits decline. Credit tightens as lenders turn cautious. A deep and prolonged contraction becomes a depression, marked by mass unemployment, falling prices and bank failures.
4. Trough. The lowest point. Output, employment and prices are at a minimum, excess capacity is widespread and pessimism is at its height. This is the lower turning point.
5. Recovery or revival. Demand revives, stocks are rebuilt, investment resumes and employment picks up, carrying the economy back into expansion.

Theories explaining the cycle

1. The Great Depression, 1929 to 1933. Output in the United States fell by about one third and unemployment reached a quarter of the workforce. World trade collapsed as countries raised tariffs against one another. It established that Government should spend to revive demand rather than wait for markets to correct.
2. The Global Financial Crisis, 2008 to 2009. A collapse in United States housing credit spread worldwide through the banking system. India's growth slowed sharply, exports fell and capital flowed out. The Government gave a fiscal stimulus and the Reserve Bank cut interest rates.
3. The COVID-19 contraction, 2020 to 2021. A national lockdown stopped activity and India's real GDP contracted over the full year for the first time in decades. Informal employment collapsed. The response combined the Atmanirbhar Bharat package, free foodgrain, sharp rate cuts and a loan moratorium.

Conclusion

Each phase carries its own policy problem: inflation at the peak and unemployment in the trough. Fiscal policy and monetary policy are used counter-cyclically, to moderate the boom and to shorten the downswing.

Meaning

A direct tax is levied on the income or wealth of a person and its burden cannot be shifted. The impact and the incidence fall on the same person. Examples: income tax and corporation tax.

An indirect tax is levied on goods and services. It is collected by an intermediary, usually the seller, and the burden is shifted to the final consumer. The impact is on the seller and the incidence on the buyer. Examples: Goods and Services Tax, customs duty and stamp duty.

Difference between direct and indirect taxes

Adam Smith's four canons of taxation, that is equality, certainty, convenience and economy, are the standard test applied to both.

Role in economic development

1. Mobilising resources. Together they finance public investment in infrastructure, health and education which private capital will not fund adequately.
2. Reducing inequality. Progressive direct taxation takes proportionately more from higher incomes and funds transfers to the poor. This is the principal equity instrument of the State.
3. Discouraging harmful consumption. Higher rates on tobacco, alcohol and luxury goods restrain consumption while raising revenue.
4. Encouraging saving and investment. Deductions for specified savings and concessional corporate rates channel funds into productive use.
5. Regional and sectoral development. Tax holidays and area based exemptions draw industry to backward regions.
6. Controlling inflation. Higher taxation reduces disposable income and cools demand.
7. Protecting domestic industry. Customs duty makes imports costlier and shields domestic producers.

Meaning

The money market is the market for short term funds, dealing in instruments of up to one year's maturity. It is distinguished from the capital market, which deals in long term funds. In India it is regulated by the Reserve Bank of India, and its central purpose is to let banks, companies and the Government adjust short term surpluses and deficits of cash.

Structure

1. Organised sector. The Reserve Bank of India at the apex, commercial banks, cooperative banks, non-banking financial companies, primary dealers and money market mutual funds. It is regulated and its rates respond to RBI policy.
2. Unorganised sector. Indigenous bankers, moneylenders, chit funds and nidhis. It lies outside RBI control, keeps no uniform accounts and charges very high rates.

Instruments

2. Strength of the unorganised sector in rural areas, where moneylenders still lend at rates far above the formal system.
3. Weak integration between segments. Rates historically differed between segments and regions because funds did not move freely between them.
4. Seasonality. Demand for funds rises in the busy season from October to April, when the harvest is moved and traded, and falls in the slack season, which once produced sharp seasonal swings in interest rates.
5. Underdeveloped bill market. A genuine market in trade bills, of the kind that developed in London, never took root in India, so short term lending runs through cash credit and overdraft.
6. Thin secondary market. Commercial paper and certificates of deposit are largely held to maturity, which limits liquidity.
7. Shortage of funds in the busy season, and an absence of a single uniform rate of interest.
8. Growing regulation and integration. The Liquidity Adjustment Facility gives the market a corridor. The repo rate is the policy rate, the Standing Deposit Facility, introduced in April 2022 and set 25 basis points below the repo rate, forms the floor, and the Marginal Standing Facility forms the ceiling.

Where the problem lies. Imports of goods exceeding exports is a deficit on the balance of trade, that is on the visible component. Merchandise trade sits inside the current account, so a large trade deficit pulls the whole current account into deficit, offset only partly by invisibles such as software exports and remittances.

How it must be financed. Because the account balances as an accounting identity, the deficit is met either by net inflows on the capital account or by drawing down foreign exchange reserves.

Kinds of disequilibrium. A deficit may be cyclical, arising from the trade cycle; structural, arising from a lasting change in demand, technology or the pattern of production; or secular, arising slowly over a long period as an economy develops.

Consequences. Demand for foreign currency exceeds the supply earned by exports, so the rupee comes under pressure to depreciate. Financing by portfolio capital is unstable because it can leave quickly, and financing from reserves shrinks the cushion. India's 1991 crisis, when reserves fell to about two weeks of imports, is the standard illustration.

Conclusion

A current account deficit is not an accounting failure but a warning about the sustainability of external finances. It is corrected by earning more foreign exchange rather than by borrowing more of it, which is why export promotion is the durable remedy and exchange rate management only the immediate one.

2. The State's share of central taxes. Under Article 270 the net proceeds of most Union taxes are shared with the States in the manner recommended by the Finance Commission. The Sixteenth Finance Commission, whose report was tabled on 1 February 2026 for the period 2026-27 to 2030-31, has recommended a State share of 41 per cent of the divisible pool.

2. Non-tax revenue. Income which the State earns rather than levies, and in which the payer usually receives a direct service in return.

1. Interest receipts on loans advanced by the State.
2. Dividends and profits from State public sector undertakings.
3. Fees and user charges, such as tuition fees, court fees and licence fees.
4. Royalties from minerals, and receipts from forests and irrigation.
5. Fines and penalties, which are levied to punish rather than to earn.

To these are added grants-in-aid from the Centre under Article 275, which are transfers rather than earnings, and capital receipts such as borrowings and disinvestment, which are not revenue at all because they create a liability or reduce an asset.

Conclusion

Health and education are State List subjects, so the duty to spend rests with the State, while the most productive tax bases, income and corporation tax, belong to the Union. This mismatch is the core of India's fiscal federalism problem, and it is why devolution and compliance matter more to a State than fresh taxation.

The nature of the problem. India's difficulty is not availability. Food Corporation of India buffer stocks routinely exceed the prescribed norms and India is a net exporter of rice. A shortage in rural areas is therefore a failure of access and distribution, not of national supply. The system rests on procurement at a minimum support price, storage by the Food Corporation of India, and distribution through fair price shops.

Causes.

1. Leakage and diversion of grain to the open market before it reaches the ration shop.
2. Exclusion errors. Coverage under the National Food Security Act is still calculated on Census 2011 population figures, so households which have since become eligible remain outside the list.
3. Last mile failures, such as irregular lifting of quotas by States, shops which do not open reliably and dealers who under-weigh.
4. Storage and transport losses, from inadequate scientific storage and long haulage from surplus to deficit States.

(b) Two steps to improve distribution and availability

1. Complete the digitisation and audit of the public distribution system. End to end computerisation of the supply chain, Aadhaar authenticated electronic point of sale devices at every fair price shop, GPS tracking of grain in transit, full use of One Nation One Ration Card so a migrant can draw the entitlement anywhere, and compulsory social audit by the gram sabha, since the beneficiaries themselves are the most reliable detectors of a shop that is short-weighing.

2. Decentralised procurement, better storage and a wider basket. Procuring grain locally in or near deficit regions instead of hauling it across the country cuts transport cost and transit loss and pays local farmers a support price. Expanding scientific and covered storage reduces the grain lost to weather and pests. Widening the basket beyond rice and wheat to millets and pulses addresses the nutritional side, which cereal supply alone cannot solve.

(a) The market structure in each case

Electricity: monopoly, and specifically a natural monopoly.

A monopoly is a market with a single seller, no close substitute for the product, and barriers which prevent entry. All three conditions are present.

2. Product differentiation. The goods are similar but not identical, being distinguished by brand, quality, shop location, service, packaging and credit. This is the essential feature and the reason it is not perfect competition.
3. Free entry and exit, since anyone may open a grocery shop.
4. Some control over price, because differentiation creates a degree of customer loyalty. The demand curve facing each shop slopes downward but is highly elastic, since a large price rise sends buyers next door.
5. Non-price competition through display, service and local advertising.
6. Excess capacity in the long run, because free entry drives profits to normal while each firm still operates below its lowest cost scale.

(b) One advantage and one disadvantage of each, for consumers

Electricity, monopoly

Conclusion

The two structures call for opposite legal treatment. A natural monopoly cannot be cured by introducing competition, because competition in it is wasteful by definition, so the monopolist is regulated instead: electricity distribution is governed by the Electricity Act 2003 and tariffs are fixed by the State Electricity Regulatory Commission, which performs the task competition would otherwise perform. In monopolistic competition rivalry already disciplines price, so the law protects the process of competition, under Section 3(3) of the Competition Act 2002 against price fixing between the shops, and under the Consumer Protection Act 2019 against unfair trade practices such as short weight.

For full marks, cover: the three levels; the WTO (establishment, functions, principles, the five gains to India with Novartis and the Bali peace clause); SAARC (SAFTA, why it is dormant); BRICS (eleven members, the New Development Bank, the Contingent Reserve Arrangement); the comparison table; a conclusion.

Introduction

The three bodies work at three different levels. The WTO is multilateral and global and sets the rules of world trade. SAARC is regional and covers South Asia. BRICS is a plurilateral grouping of major emerging economies with no treaty and no rulebook. India's interest in each is different, and each is taken in turn.

Governing principles. Most Favoured Nation treatment, so a concession to one member extends to all. National Treatment, so imported goods are treated no worse than domestic goods once inside the market. Binding tariff commitments. Transparency. Special and differential treatment for developing countries.

Main agreements. GATT for goods; GATS for services; TRIPS for intellectual property; the Agreement on Agriculture; and the agreements on anti dumping, subsidies and safeguards.

How the WTO helps India.

1. Predictable market access. Indian exporters face bound tariffs in every member market and cannot be singled out for discrimination.
2. Dispute settlement. A rules based system lets a smaller economy compel a larger one to comply, which bilateral bargaining never could.
3. Services exports. The GATS underpins India's software and business services trade, and India presses for easier temporary movement of professionals.

Objectives. To promote the welfare of the peoples of South Asia, accelerate economic growth, social progress and cultural development, and strengthen collective self reliance.

Structure. Summits of heads of state are the highest authority. Decisions are by unanimity, and the Charter excludes bilateral and contentious issues. Both rules were meant to protect the organisation from the region's disputes, and both have instead paralysed it.

Achievements.

1. The South Asian Free Trade Area (SAFTA), in force from 1 January 2006.
2. The SAARC Development Fund, the South Asian University at Delhi, and the SAARC Disaster Management Centre.
3. The SAARC COVID-19 Emergency Fund, proposed by India in March 2020, which showed the framework can still be used when circumstances allow.

Institutions.

1. The New Development Bank, established 2015, headquartered at Shanghai, financing infrastructure and sustainable development in member states.
2. The Contingent Reserve Arrangement, a currency swap facility of 100 billion US dollars for members under balance of payments pressure.

How BRICS helps India.

1. A voice for the Global South, pressing for reform of the IMF, the World Bank and the United Nations Security Council.
2. Development finance without policy conditionality. The New Development Bank has financed Indian metro rail, renewable energy, water and road projects.
3. External insurance, since the Contingent Reserve Arrangement stands behind India's own reserves.
4. Energy security, with Russia, Iran, Saudi Arabia and the UAE inside the same grouping as one of the world's largest crude importers.
5. Cooperation on climate finance, counter terrorism, health and digital payments.

Conclusion

The WTO gives India enforceable rules, BRICS gives it a voice and development finance, and SAARC gives it a framework which at present does not function. India's practical course is to use the first two fully while keeping the third in reserve, and its examples, from Novartis to the Bali peace clause to the New Development Bank's Indian projects, show each body serving a different national interest.

The sector contributes roughly 30 per cent of GDP, about 35 per cent of manufacturing output and close to 45 per cent of exports, and after agriculture it is the second largest source of employment in India. Its problems therefore matter far beyond the firms themselves.

Main problems faced by MSMEs

1. Inadequate and costly credit. The central problem. Banks want collateral a small enterprise does not have, and appraising a firm without audited accounts or credit history is expensive, so credit is refused or priced high. A large share of the sector still borrows from informal lenders at very high rates.
2. Delayed payments. Large buyers routinely pay small suppliers late, locking up the working capital of firms that have none to spare. This single practice closes more small enterprises than any other.
3. Technological obsolescence. Old machinery, negligible research and development, and difficulty meeting the quality certifications that large buyers and export markets demand.
4. Weak marketing and market access. No brand, no distribution reach, and little bargaining power against organised retail and large competitors.

2. The revised classification of 1 April 2025 raised the ceilings so that a growing firm does not lose its benefits merely for growing, and non tax benefits continue for a period even after a firm graduates out of its class.

Credit

1. Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE), guaranteeing loans so banks can lend without collateral, which meets the central problem head on.
2. Priority Sector Lending norms of the Reserve Bank, obliging banks to direct a prescribed share of credit to the sector.
3. Pradhan Mantri Mudra Yojana, micro loans for non corporate, non farm enterprises.
4. The Emergency Credit Line Guarantee Scheme of 2020, fully guaranteed emergency credit that carried lakhs of MSMEs through the COVID contraction, the standing example of counter cyclical support.

Delayed payments

1. RAMP (Raising and Accelerating MSME Performance), launched in 2022 with World Bank support, for market access, competitiveness and greening.
2. The MSE Cluster Development Programme, technology centres, ZED certification (Zero Defect Zero Effect) and lean manufacturing schemes.
3. Prime Minister's Employment Generation Programme, a credit linked subsidy for setting up new micro enterprises.
4. PM Vishwakarma, from September 2023, for eighteen traditional artisan trades: collateral free loans, a toolkit incentive and skill training.

Assessment

On paper the schemes cover every listed problem. In practice the binding constraint has shifted from availability to access: guarantees exist but reach a fraction of eligible firms, and the delayed payment machinery exists but a small supplier hesitates to invoke it against a buyer it depends on for future orders. Registration through Udyam matters most, because a firm outside the system is beyond the reach of every remedy inside it.

For full marks, cover: Article 265; the classification tree (revenue against capital receipts, tax against non-tax, direct against indirect, with GST 2025 and the Income-tax Act 2025); the rupee table; six or more reasons the revenue matters; the concerns (narrow base, cess outside the pool); a conclusion.

Introduction

Public revenue is the income of the Government from all sources, raised to finance public expenditure. Article 265 of the Constitution provides that no tax shall be levied or collected except by authority of law, so every source below rests on a statute, and the annual Finance Act renews the rates.

Classification of public revenue

A. Revenue receipts, which neither create a liability nor reduce an asset. These are revenue proper.

1. Tax revenue. A tax is a compulsory payment to the State with no direct return promised to the payer: the taxpayer cannot demand a specific service in exchange.

1. Interest on loans advanced to States and public bodies.
2. Dividends and profits of public sector undertakings, and the annual surplus transferred by the Reserve Bank of India, in recent years among the largest single non tax items.
3. Fees and user charges: court fees, licence fees, tuition fees, tolls.
4. Fines and penalties, imposed to punish rather than to earn.
5. Royalties on minerals, receipts from spectrum auctions, forests and irrigation.
6. Grants received from external sources.

B. Capital receipts, which create a liability or reduce an asset, and therefore finance the Budget without being income:

1. Borrowings: market loans, small savings, external assistance.
2. Disinvestment of Government equity in public undertakings.
3. Recovery of loans advanced earlier.

1. They finance public goods that markets will not supply: defence, police, the courts, public administration and basic research benefit everyone and can be sold to no one, so only public revenue can pay for them.
2. They build human capital. Public spending on education and health raises the productivity of the workforce, which is the foundation of long run growth rather than a welfare cost.
3. They build infrastructure. Capital expenditure on roads, railways, ports and power lowers costs across the whole economy and draws private investment in behind it.
4. They redistribute. Progressive direct taxation takes proportionately more from higher incomes and finances transfers, subsidies and free foodgrain under the National Food Security Act; this is the State's principal equity instrument.
5. They manage the macroeconomy. Fiscal policy works through revenue and expenditure, and a government with a dependable revenue base can spend counter cyclically in a downturn, as India did through the COVID contraction.

3. Cess and surcharge collections stay outside the divisible pool shared with the States, a standing grievance of fiscal federalism.
4. Dependence on a few buoyant sources, so a slowdown transmits straight to the Budget.

Conclusion

Public revenue is not merely how the State pays its bills: its composition decides who bears the cost of development. India's task is to widen the base rather than raise the rates, because a broader base finances growth without borrowing and without loading the burden onto regressive indirect taxation.

The poverty line

The poverty line is the level of per capita consumption expenditure below which a person is counted as poor. In India it was anchored originally to a minimum calorie norm: 2,400 calories per person per day in rural areas and 2,100 in urban areas, the urban figure lower because urban work is less physically demanding.

The committees that defined it

1. Y.K. Alagh Committee, 1979. Fixed the calorie based norms.
2. Lakdawala Committee, 1993. Introduced State specific poverty lines updated by separate price indices for rural and urban areas.
3. Tendulkar Committee, 2009. Moved away from pure calorie anchoring, included spending on health and education, and fixed the line near Rs. 27 per person per day rural and Rs. 33 urban at 2011-12 prices, giving a head count ratio of 21.9 per cent for 2011-12.
4. Rangarajan Committee, 2014. Raised the line to about Rs. 32 rural and Rs. 47 urban, giving 29.5 per cent for 2011-12; its report was never formally adopted.

4. Slow growth of the formal sector, leaving most workers in low productivity informal work with no security.
5. Unequal distribution of assets, above all land, so growth bypasses those who own nothing it can work through.
6. Illiteracy and lack of skills, which confine the poor to low wage work and carry poverty into the next generation.
7. Ill health and medical costs. Out of pocket spending on illness pushes households below the line every year, which is why health policy is poverty policy.
8. Social factors: caste and gender discrimination, large families, ceremonial expenditure and chronic debt to moneylenders.
9. Regional concentration, poverty being heaviest in Bihar, Jharkhand, Uttar Pradesh, Madhya Pradesh and Odisha.
10. Inflation, which erodes the real income of the poor fastest because food is the largest share of their spending.

2. Mid day meals, the Integrated Child Development Services and the nutrition mission, aimed at the youngest.

Housing, water, sanitation and energy

1. PM Awas Yojana for housing, Swachh Bharat Mission for sanitation, Jal Jeevan Mission for piped water, Ujjwala for cooking gas, and rural electrification, each removing one deprivation the MPI counts.

Health and social security

1. Ayushman Bharat PM-JAY, hospital cover of Rs. 5 lakh per family per year for the poorest households, aimed squarely at medical impoverishment.
2. Atal Pension Yojana and the low cost life and accident insurance schemes.

Financial inclusion and direct transfer

1. Jan Dhan accounts, Aadhaar and Direct Benefit Transfer, which pay the beneficiary directly and cut the leakage that consumed earlier programmes.
2. PM Kisan Samman Nidhi for farm households and Mudra credit for micro enterprise.

Area based development

For full marks, cover: the Part XII scheme; taxing powers with Articles 246A and 279A; the vertical and horizontal imbalances; the four transfer channels (Articles 270, 275, 282, 293); Article 280 with composition, functions and advisory force; the Sixteenth Finance Commission (41 per cent, the GDP criterion, the 3 per cent cap); how balance is maintained; a conclusion.

Introduction

Financial relations between the Union and the States are governed by Part XII of the Constitution, Articles 264 to 293, and the institution the Constitution builds at their centre is the Finance Commission under Article 280. The scheme divides the power to tax, accepts the imbalance that division creates, and then corrects the imbalance through transfers.

1. Distribution of taxing powers

1. Vertical imbalance. The Union holds the elastic and productive bases, because income, corporate profit and imports are national in character and cannot be taxed State by State without chaos. The States carry the heavier spending duties, because public health, agriculture, police, water supply and much of education lie in the State and Concurrent Lists. The level with the duty to spend is not the level with the power to tax.
2. Horizontal imbalance. States differ sharply in income and in the capacity to raise revenue from their own bases, so equal treatment would leave unequal services.

3. The transfer machinery that corrects it

1. Tax devolution under Article 270. The net proceeds of most Union taxes are shared with the States as the Finance Commission recommends. Devolved money is untied: a State spends it on its own priorities.
2. Grants-in-aid under Article 275, for States in need of assistance, again on the Commission's recommendation.

3. To recommend measures to augment a State's Consolidated Fund to supplement the resources of panchayats and municipalities, added by the 73rd and 74th Amendments.
4. Any other matter the President refers.

Binding force. The recommendations are advisory, but by settled convention the Government accepts the core devolution recommendations, and under Article 281 the report is laid before Parliament with a memorandum of action taken, which makes departure politically costly.

5. The Sixteenth Finance Commission

Chaired by Dr. Arvind Panagariya, its report covers 2026-27 to 2030-31 and was tabled in Parliament on 1 February 2026.

1. Vertical devolution retained at 41 per cent of the divisible pool.

4. It strengthens the third tier, recommending grants that flow through States to panchayats and municipalities.
5. It fills residual gaps, through revenue deficit grants, sector specific grants and disaster financing.
6. It anchors fiscal discipline, setting debt and deficit paths for both levels of government.
7. It gives predictability. A five year award lets a State plan capital expenditure with known resources, which is the precondition of development spending.

Points of tension

1. Cess and surcharge stay outside the divisible pool, so the States' effective share of gross Union collections is materially below the headline 41 per cent, and the share of cesses has grown.
2. The GDP contribution criterion rewards States already prosperous, and its equity is contested.
3. Tied transfers under Article 282 continue to grow relative to untied devolution.