Emerging dynamics of India’s fiscal federalism 

Syllabus: GS2/ Polity and Governance 

In Context

• There are a number of issues that have varying consequences on India’s fiscal federalism which need review.

About Fiscal Federalism

• About: It deals with the division of financial powers as well as the functions between multiple levels of the federal government. 
  • It has within its ambit the imposition of taxes as well as the division of different taxes between the Centre and the constituent units. 
  • Similarly, in the case of joint collection of taxes, an objective criterion is determined for the fair division of funds between the entities. 
  • Usually, there is a constitutional authority (like Finance Commission in India) for the purpose to ensure fairness in the division.

Significance of fiscal federalism

• Fiscal federalism broadly considers the vertical structure of the public sector, fiscal policy institutions and their interdependence.
• Fiscal federalism is significant broadly due to following reasons:
  • To determine at which level of government to assign different expenditure responsibilities. 
  • To determine the strategy to finance a given level of public goods and services. 
  • To adopt strategies to cap excessive spending and borrowing at each level of government.

Emerging dynamics of India’s fiscal federalism

• Recent changes in India’s fiscal policies: The paradigm shift from a planned economy to a market-mediated economic system, 
  • The transformation of a two-tier federation into a multi-tier fiscal system following the 73rd and 74th Constitutional Amendments, 
  • The abolition of the Planning Commission and its replacement with NITI Aayog, 
  • The passing of the Fiscal Responsibility and Budget Management (FRBM) Act,
  • The Goods and Services (GST) Act with the GST Council holding the controlling lever, 
  • The extensive use of cess and surcharges which affect the size of the divisible pool and so on.
• These changes have altered the fiscal landscape with varying consequences on India’s federalism.

Consequences, Issues & challenges

• Disproportionate approbation: The tax exemptions, tax concessions and other revenues forgone in recent times disproportionately favoured the rich and have reduced the size of the divisible pool. 
  • The Human Development Index (HDI) across 15 States shows a convergence during the post-reform period. The standard deviation value of HDI is reduced to 0.268 in 2018 from 0.611 in 1991.
• Overburdening states: Under the changing dispensation, several pieces of central legislation such as the Mahatma Gandhi National Rural Employment Guarantee Act 2005, the Right of Children to Free and Compulsory Education Act 2009, the National Food Security Act 2013 and many others impose an extra burden on the States. 
• Confusion & disordering: Confusion with respect to division of functions and finance was added with the introduction of Schedule XI and Schedule XII.
  • Both the schedules respectively, list out the subject matter for the panchayat raj institutions and municipalities by simply lifting items from the State list and Concurrent list. 
  • They lack operational meaning unless they are broken down into activities and sub-activities.
• Absence of a uniform financial reporting system: The persistent failure to place the third tier properly on the fiscal federal map of India is a serious issue. 
  • The absence of a uniform financial reporting system (standard budgeting rules for all tiers, introduction of the accrual-based accounting system long recommended and so on) comprising all levels of government is a major shortfall.
• Unscrutinised Off-Budget borrowings: There is a great need to review the off-Budget borrowing practices of both the Union and the States. Off-Budget borrowings mean all borrowings not provided for in the Budget but whose repayment liabilities fall on the Budget. 
  • They are generally unscrutinised and unreported. 
• Containing the revenue deficit of States: The reduction in fiscal deficit has not been accompanied by a corresponding reduction in revenue deficit. 
  • As of 2023-24 (BE), out of 17 major States, 13 States have deficits in the revenue account. 
  • Out of 13 States, fiscal deficits in seven States are primarily driven by revenue deficits; the States being Andhra Pradesh, Haryana, Kerala, Punjab, Rajasthan, Tamil Nadu, and West Bengal. They also have large debt to GSDP ratios.
• Long-run implications of fiscal stress: An assessment of successive Finance Commissions since the Twelfth Finance Commission identified three States, i.e., Kerala, Punjab and West Bengal, as fiscally stressed States.
  • Increasing revenue deficit driving the fiscal imbalance has long-run fiscal implications and there is a need to correct this imbalance in the revenue account.

Way ahead

• The nature of polity, society, technology, demographic structure and the development paradigm itself have significantly changed.
• It is well-recognised that the prime objective of our federation with deep heterogeneity is to provide basic services of standard quality to every citizen irrespective of her choice of residence and they have a critical role to play.
• The dynamics of the emerging fiscal federalism of India entails significant rethinking especially in the context of the 16th Finance Commission.

Source: TH