State of India’s Fiscal Federalism

In Context 

The concerns of the founding fathers for addressing socio-economic inequities are being forgotten in today’s fiscal policy.

Degree of centralisation in Fiscal power

• A degree of centralisation in fiscal power was required to address the concerns of socio-economic and regional disparities. 
  • This asymmetric federalism was accelerated and mutually reinforced with political centralisation since 2014, making the Union Government extractive rather than enabling. 
  • States lost their capacity to generate revenue by surrendering their rights in the wake of the Goods and Services Tax (GST) regime
  • Their expenditure pattern too was distorted by the Union’s intrusion, particularly through its centrally sponsored schemes .

Broadening powers of the Finance Commission. 

• Historically, India’s fiscal transfer worked through two pillars, i.e., the Planning Commission and the Finance Commission. 
  • But abolition of the Planning Commission in 2014 led to the Finance Commission becoming a major means of fiscal transfer as the commission itself broadened its scope of sharing all taxes since 2000 from its original design of just two taxes — income tax and Union excise duties.
  • Today, the Finance Commission became a politicised institution with arbitrariness and inherent bias towards the Union government. 

Observations of P.V. Rajamannar committee 

• The Dravida Munnetra Kazhagam constituted a committee under Justice P.V. Rajamannar in 1969, the first of its kind by a State government, to look at Centre-State fiscal relations and recommend more transfers and taxation powers for regional governments. 

Issues /Challenges

• Hollowing out fiscal capacity
  • The ability of States to finance current expenditures from their own revenues has declined from 69% in 1955-56 to less than 38% in 2019-20.
  • States cannot raise tax revenue because of curtailed indirect tax rights — subsumed in GST, except for petroleum products, electricity and alcohol — the revenue has been stagnant at 6% of GDP in the past decade.
• Differential interest 
  • States are forced to pay differential interest — about 10% against 7% — by the Union for market borrowings. 
    • the Union gains at the expense of States by exploiting these interest rate differentials.
• Curbing autonomy and diversion of a State’s own funds
  •  There are 131 centrally sponsored schemes, with a few dozen of them accounting for 90% of the allocation, and States required to share a part of the cost. 
    • States autonomy has been curbed by turning them into mere implementing agencies of the Union’s schemes

• These schemes, driven by the one-size-fits-all approach, are given precedence over State schemes, undermining the electorally mandated democratic politics of States.

• The diversion of a State’s own funds to centrally sponsored schemes, thereby depleting resources for its own schemes, violates constitutional provision. 

• Deepening inequality
  • The political centralisation has only deepened inequality. 
    • The poorest half of the population has less than 6% of the wealth while the top 10% nearly grab two-third of it’.

Conclusion and Way Forward 

• In sum, India’s fiscal federalism driven by political centralisation has deepened socio-economic inequality, belying the dreams of the founding fathers who saw a cure for such inequities in planning. 
  •  If there was anything that alleviated poverty, reduced inequality and improved the well-being of people, these were the time-tested schemes of State governments, but they are now under threat.
    • Therefore ,the states should be given some autonomy 
• Distribution of resources is also essential alongside decentralisation of powers for achieving economic growth.
• If needed ,the State Legislature will have to take a collective stand to resist the Centre’s policy of suffocating the States’ right
• The Union government needs to invest resources towards facilitating effective consultation with States as a part of the lawmaking process.
•  It is critical that the Union establishes a system where citizens and States are treated as partners and not subjects.
• The states need to be given the right to modify the SGST within a narrow band to introduce some level of federal flexibility into the GST. 
• Recommendations of P.V. The Rajamannar committee needs to be considered .
• Some urgent necessary measures need to be taken for pumping oxygen to fiscal federalism in India.