Fiscal federalism refers to the division of responsibilities with regards to public expenditure and taxation between the different levels of the government. Having a fiscal federalism mechanism allows the government to optimize their costs on economies of scale, because in this manner, people will get public service which they prefer, and there will be no unnecessary expenditure. From the economic point of view also, having a federalised structure helps as it creates a unified market.
India has a federal form of government, and hence a federal finance system. The essence of federal form of government is that the Centre and the state governments should be independent of each other in their respective, constitutionally demarcated spheres of action. Once the fundamentals of the government are spelt out, it becomes equally important that each of the government should be provided with sources of raising adequate revenues to discharge the functions entrusted to it.
Constitutional Provisions
The fiscal powers and functional responsibilities in India have been divided between the Central and State governments following the principles of federal finance. Article 246 of the Constitution lays down the list of subjects on which different levels of government can make laws. The division of functions is specified in the Seventh Schedule of the Constitution in three lists vis. the Union List, the State List and the Concurrent List.
The Union List contains 97 subjects of national importance, such as defence, railways, national highways, navigation, atomic energy, and posts and telegraphs. 66 items of State and local interest, such as law and order, public health, agriculture, irrigation, power, rural and community development, etc. have been entrusted to the state governments. 47 items such as industrial and commercial monopolies, economic and social planning, labour welfare and justice, etc. have been enumerated in the Concurrent List. The concurrent list is one in which both state and the Centre can make legislations. However, in case of a conflict or tie, federal laws prevail. Similarly, the borrowing powers have also been clearly mentioned in the Constitution. Under Article 292, the Central government is empowered to borrow funds from within and outside the country as per the limits imposed by the Parliament. According to Article 293(3), the States can borrow funds within the Country. Article 293(2) empowers the Centre to provide loans to state subject to conditions laid down by Parliament.
Fiscal Imbalances in India
Fiscal imbalance occurs when there is a mismatch between a government’s future debt obligations and future income streams.
Vertical Fiscal Imbalance occurs when the revenues of different levels of government (i.e. centre, state and local) do not match their expenditures responsibilities. There is a mismatch in the revenue capacity and expenditure responsibilities of the central, state and local govt. The lower level government (state and local) are often dependent on the central govt for finances to meet their expenditure responsibilities and this necessitates inter-governmental transfers from central govt to lower level governments.
Horizontal fiscal imbalance occurs when governments at the same level in different regions of a country have different abilities to provide services due to different abilities of raising funds. For example, not all states or municipalities in India raise equal amount of tax revenue, which will ultimately define the quality of services provided by individual states to their respective people. Then some region have higher cost of services compared to other regions, so this kind of an imbalance or mismatch in the revenue and expenditure accounts of governments at same level is known as horizontal fiscal imbalance.
Typically, federations (including the Indian one) face vertical and horizontal imbalances. A vertical imbalance arises because the tax systems are designed in a manner that yields much greater tax revenues to the Central government when compared to the state or provincial governments; the Constitution mandates relatively greater responsibilities to the state governments. For example, in India, post the advent of Goods and Services Tax (GST), the share of states in the public expenditure is 60% while it is 40% for the Centre to perform their constitutionally mandated duties.
Justifying Centripetal Biases
For the analysis of Indian fiscal federalism, nevertheless, it must be kept in mind that the Indian federation differs from the developed federations in many important respects.
First, India is vast country with wide inter-regional differences in economic endowments as well as levels of income, and is faced with conflicting tendencies of centralisation and decentralisation, the former designed to reduce inter-regional disparities and the latter to meet the diverse patterns of demand. Besides, the Indian economy is faced with severe interjurisdictional competition, underlining the need for utmost cooperation among various jurisdictions.
Second, the low levels of income and wide inter-regional disparities have necessitated governmental intervention not just in the provision of public services; the government has taken the major responsibility for economic development of the country by taking up the role of both catalyst and an entrepreneur. The multilevel planning adopted for the purpose has brought forth additional com plexities in the fiscal arrangements in terms of heavy fiscal dependence of the states on the Centre, high degree of vertical and horizontal tax and expenditure spillovers and multiplicity in intergovernmental transfer schemes with overlapping and ambiguously defined objectives.
Third, as the pattern of investments in pre-independent era was largely determined on the basis of colonial interests of the ruling power, the differences in the levels of development currently in vogue among the states do not necessarily represent their varied resource endowments.
Finally, the existence of wide inter-regional differences in the levels of development itself under lines a significant role for inter- governmental equitable transfer schemes, as the nexus between levels of development and resource endowments seems to be tenuous in most cases. In such a situation, equitable transfers at the expense of richer states may not necessarily result in lower economic growth.
The Case of Horizontal Imbalances
The horizontal imbalances arise because of differing levels of attainment by the states due to differential growth rates and their developmental status in terms of the state of social or infrastructure capital. Traditionally, Finance Commissions have dealt with these imbalances in a stellar manner, and they should continue to be the first pillar of the new fiscal federal structure of India.
However, in India, the phenomenon of horizontal imbalance needs to be understood in a more nuanced fashion. It involves two types of imbalances. Type I is to do with the adequate provision of basic public goods and services, while the second, Type II, is due to growth accelerating infrastructure or the transformational capital deficits. The latter are known to be historically conditioned or path dependent. It is here that we believe that NITI Aayog must create a niche, assume the role of another policy instrument and become the second pillar of the new fiscal federal structure.
What Can be Done?
Reimagining NITI Aayog
In the past, the Planning Commission used to give grants to the states as conditional transfers using the Gadgil-Mukherjee formula. Now with the Planning Commission disbanded, there is a vacuum especially as the NITI Aayog is primarily a think tank with no resources to dispense, which renders it toothless to undertake a “transformational” intervention. On the other hand, it is too much to expect the Union Finance Commission to do the dual job. In other words, there is an urgent need for an optimal arrangement. It is best that the Union Finance Commission be confined to focussing on the removal of the horizontal imbalance across states of the Type I: i.e. the basic public goods imbalance. We need another institution to tackle the horizontal imbalance of the Type II; for this the NITI Aayog is the most appropriate institution. It can be argued that the Finance Ministry is the other alternative to deliver the goods in this regard but it is ill-suited to do this; its primary duty is to concern itself with the country’s macro-economic stability and the proper functioning of the financial system rather than be an instrument of growth at the subnational level.
Towards this task of cooperative federalism, NITI Aayog should receive significant resources (say 1% to 2% of the GDP) to promote accelerated growth in States that are lagging and overcome their historically conditioned infrastructure deficit, thus reducing the developmental imbalance. In short, the NITI Aayog should be engaged with the allocation of “transformational” capital in a formulaic manner, complete with incentive-compatible conditionalities.
NITI Aayog should also be mandated to create an independent evaluation office which will monitor and evaluate the efficacy of the utilisation of such grants. In doing so, it should not commit the mistake of micro-management or conflicts with line departments. It must be also accorded a place at the high table of decision-making as it will need to objectively buy-in the cooperation of the richer states as their resources are transferred to the poorer ones.
Eduindex News 
You must be logged in to post a comment.