Date : 29/08/2023

Relevance –

• GS Paper 2 – Polity
• GS Paper 3 – Indian Economy

Keywords – Fiscal federalism, Off-budget borrowing, GST, FRBM

Context –

An integrated federation with a leaning towards unitary principles, the Indian Constitution has traversed more than seven decades with impressive durability. Nonetheless, the evolving intricacies of India's fiscal federalism, pertaining to the financial interactions between the central and state governments, require some reconsideration.

Rationale for the Need to Reconsider India's Fiscal Federalism

Evolved Fiscal Landscape

Certain choices and actions undertaken by the central government have reshaped the fiscal landscape, encompassing:

• The shift from a planned economy to a market-driven economic structure.
• The evolution from a two-tier federation to a multi-tier fiscal framework post the 73rd and 74th Constitutional Amendments.
• The replacement of the Planning Commission by NITI Aayog.
• Enactment of the Fiscal Responsibility and Budget Management (FRBM) Act.
• Introduction of the Goods and Services (GST) Act, with control vested in the GST Council.
• Increased reliance on cess and surcharges, impacting the divisible pool's size.

Intricate System of Intergovernmental Fiscal Relationships

• This intricacy originates from multiple sources, including notable disparities in ethnicity, societal dynamics, and economic conditions across regions.
• The persisting vertical imbalance between state governments' expenditure and revenue-generation responsibilities exacerbates the issue.
• This imbalance is partly mitigated by revenue-sharing agreements. States also receive diverse grants from the central government, yet deficits persist.
• Given these factors, coupled with the evident shift towards transforming the economy's structure away from central planning and amplified demands from states for fiscal independence, a comprehensive reassessment becomes imperative.

Approaches to Address India's Fiscal Federalism Challenges

Equitable Intergovernmental Transfers

In the 1930s, the top 1% of income earners in India held less than 21% of total income, which saw a significant drop to 6% in the early 1980s, but surged to 22% during the era of economic liberalization. Moreover, recent instances of tax exemptions and concessions disproportionately favored the affluent, consequently shrinking the divisible pool's size. To rectify this, India's intergovernmental transfer system should prioritize equity.

Incorporate HDI into Horizontal Distribution (Allocation Among States)

Analysis of the convergence trajectory of per capita income (PCI) among 16 major States from 1970-71 to 2020-21 demonstrates a growing divergence. Conversely, the Human Development Index (HDI) among 15 States exhibits convergence in the post-reform era, with HDI's standard deviation decreasing from 0.611 in 1991 to 0.268 in 2018. Consequently, considering HDI as a key factor in the horizontal allocation of tax devolution holds merit.

Re-evaluate Article 246 for Precise Division of Authorities

The Indian Constitution's Article 246 and 7th Schedule allocate powers and subjects to the Union and states, categorized under Union, State, and Concurrent Lists. Given India's transition from post-Independence single-party governance to a multi-party system, and considering shifts in polity, society, technology, demographics, and development paradigms, a clear demarcation of authority becomes essential. Instances like the MGNREGA 2005, Right to Education Act 2009, and National Food Security Act 2013 impose additional burdens on states, highlighting the need for clear power division.

Implement Subsidiarity Principle

During constitution-making, the principle of subsidiarity – performing functions at the most appropriate level – wasn't fully applied. Incorporating this principle was an opportunity offered by the 73rd and 74th Constitutional Amendments, which wasn't fully utilized. The introduction of Schedule XI and Schedule XII added more complexity by merely borrowing items from the State and Concurrent Lists without breaking them down into operational activities. The example set by states like Kerala, which have successfully broken down these lists into activities and sub-activities, serves as a model.

Elevate the Third Tier's Status

While the Constitution refers to the third tier as 'institutions of self-government', the term 'local bodies' is more commonly used by policymakers, often undervaluing their importance. This has hindered the development of India's local democratic foundation, which includes over 3.2 million elected representatives and 2.5 lakh rural and urban local governments. Acknowledging their critical role in delivering quality basic services to citizens is crucial.

Review Off-Budget Borrowing Practices

Reassessing off-budget borrowing practices of both Union and State governments is essential. These borrowings, not included in the budget but accountable to it, tend to lack scrutiny and reporting. While Article 293(3) and the FRBM Act help regulate State borrowings, the Union often circumvents such controls. Ensuring transparency and accountability in off-budget financing is vital for both levels of government.

Enhance Transparency and Accountability in Extra-Budgetary Financing

The substantial use of the National Small Saving Fund (NSSF) for extra-budgetary financing of central public sector undertakings and ministries, facilitated through loans, is absent from the Union's fiscal deficit calculations. The existing calculation only incorporates the Consolidated Fund of India balance, excluding items like the NSSF. Upholding transparency and public accountability necessitates full disclosure of all extra-budgetary transactions by the Union, states, and local governments.

Conclusion

The existing framework of fiscal federalism in India was established during a period when its economy was notably less market-driven compared to the present day. During that time, the central government held substantial authority in economic regulation, administration, and planning.

However, given the evolving nature of fiscal federalism in India and the changing dynamics, it has become imperative to engage in substantial reconsideration, particularly in light of the developments surrounding the 16th Finance Commission.

Source – The Hindu