Fiscal

Federalism
India has 28 states governed by their own elected
parliaments. It has seven union territories which
come
under the jurisdiction of the central government: Fiscal
c relations between the Cenue and the states are shaped
by
the Seventh Schedule in the Indian Constitution
which describes the legislative, executive, and
judicial powers of the Centre and states through
the Union, State, and Concurrent lists. The division
of revenue and expenditure powers between the
Centre and states is specified by: (a) the Union List,
which states the powers that are
exclusively under the purview of the central government." y
and (b) the State List, which gives those powers
exclusively under the scate government. All residual powers
: Most taxes with a broad
rest with the Centre.

tax base are assigned to the

Centre--for example, income and wealth, rax from non-'. |
agricultural sources, corporation tax, and customs and
excise duties. Sales taxes, land revenue,
alcohol éxcises,
and agricultural income taxes are with state governments. :
Out of these, sales tax is the most significant
source
of revenus for states. An important recent
milestone - has been the adoption of VAT by
21 states in 2005. On the expenditure side,
the Centre spends on defence and
 Infrastructure while state governments spend mainly on
borghini laternal security, law and order, and
social and economic I services. Among social
services the largest proportion goes
to education, public health, and
family. '
In 1992, the 72nd and 73rd Constitutional ::
Aunendments introduced a third tier.of fiscal authority,
: giving constitutional validity to existing rural and
urban:
local governments. Till that time, local
governments
acred as agencies of siate governments: Panchayati Raj
: . Institutions. (PRIS) in the villages informally
provided
basic community and judicial services, while in
urban areas this purpose was fulfilled by
municipal authorities. The constitutional
amendments of 1992 yave these Institutions an
elective status and gave them powers
to impose 10XC8--usually property taxes in urban i
areas. Education, housing, and land use;
development
of industrial and commercial estates; and electricity
distribution are some of the functions that have
been decentralized in urban areas. ,
Traditionally, there are high deficits at both the central and store
levels: in 2004-5 the central deficit was about 4.1 per
cent of GDP. State level deficits are · similar. The deficits
can be traced back to the political unwillingness of
governments to improve the limited tax
buse and flexibility. As a result, fiscal responsibility laws.
· have been enacted: the Fiscal Responsibility and
Budger
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Management Act (FRBMA) was enacted in 2003 by the owned by the states, and revenue
from state lotteries. central government and has been followed by a number TheThirteenth
Finance Commission recommended that of states.',''
***4764 are of centraltare should increase so 32 per There is a well-documented vertical
imbalance tra i le grants to segues accounted for 11 per cent of the Centre and the statue:
in 2005-6, on average, vlera t total revenues. Hence stares' dependence on central
governments raised about 37 per cent of total revenues transfers is very high and causes many problems of
fiscal but accounted for 57 per cent of the expenditures. This "indiscipline and low tax effort. This is
improving now imbalance has grown worse over the years in 155-6..
due to the introduction of tax
efforts in the formula these figures were 41 and 59. per cent, respeively. The
 cent, respectively. The recommended by the
Finance Commission. . - imbalance was a direct result of the types cils that : Transfers from the
Centre to state governments
were assigned to the Centre and the bias in favour of the have been criticized for displaying a political bias.
This Centre, which was a legacy of the colonial system and CRITIC S cspecially directed towards
discretionary the subsequent emphasis on planned development and transfers although even
formulá-based transfers have reducing inequalities between states. The Constitution been
suspece. The proportion of discretionary transfers recognized this imbalance and provided for
assigning has been increasing over time. There are three major : revenues between the
Centre and the states as well as channels through which the Centre transfers funds to for the
sharing of revenues from the proceeds of certain .. state governments ... centrally levied
taxes. In addition to this, the Constitution (1) Tax devolucion and grants through the Finance
provides for grants from the Centre to the states. . . .Commissions (approximately 62 per
cent of total
The President of India appoints the
Finance
transfers in-2002-7).
Commission, an independent body, to determine the lin) Grants and loans given by the
Planning Commission share of the Centre and the states in shared central
(approximately 32 per cent
of total transfers in revenues and their allocation between states. The Finance 2002–71. ..
Commission was responsible for about 60 per cent of the . (iii) Transfers for various
central-sector and centrally total transfers from the.Centre to the states in 2002-7;
sponsorcd.schemes by various central ministries this figure increased to 68 per cent in
2005–9. Till 2010, aproximately 4.32 per cent of total transfers there have been 13 Finance
Commissions. The members in 2000-1). Frotn. 1969, plan transfers (that is, of the Finance
Commission include academics and postednsfers determined by the Planning
Commission) retired administrators. The Finance Commission also in have been
effected on the basis of a formula called recommends grants to states in'nced on the basis of
a
the ‘Gadgil Formula' after the
first chairman of formula that weights different states according to their ..the National
Development Council. The formula population, income, area, infrastructure, tax'effort,
antaranya is based on population, per capita income and fiscal discipline. After the 72nd and
73rd Amendments . its deviation from an average of all scares as well . 10 the
Constitution, State Finance Commissions were set as from the highest per capita
income, fiscal up analogous to the Finance Commission at the national performance, and 'special
problems'. The decision level. Similar to the asymmetry between the Centre
· making body is the National
Development Council; and the states, there is a marked asymmetry between
.. which is chaired by the Prime Minister,
and
contains all cabinet ministers at
the Centre, chief states' and local governments' revenue-raising powers. If decentralization has taken
place, it is more at.the level .. ministers of states, and members of the Planning of expenditure than
at the level of revenue generation. A .. Commission. These are called transfers on account
disproportionate share of expenditure at the local level is . of state plan schemes. Although these
transfers incurred by urban local bodies compared to turatartas. are based on a consensus
formula, discretionary Rural local bodies have so far mostly implemented grants
elements can enter into the
determination of from central ministries, usually in poverty alleviation
these grants for two
reasons. First, while each and social and community services, but are heavily
state proposes its plan size to the
Planning circumscribed by state governments and have yet to fulfil Commission, the final approval of the
size rests with their potential as independent tiers of the government.
the Commission. Hence, there is some scope for To finance thcir deficits, state governments can rely
on negotiation and persnasion'. Second, the formula both tax and non-tax revenue sources. The
latter comprise cxplicitly sets aside 7,5 per cent of the grants on interest receipts from loans issued by
state governments, account of special problems of states. This allows for dividends and profits
from public-scctor undertakings . some subjectivity to creep into the determination of

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 ..
(for example, Rao and Singh 2002) predicts that
states with higher representation in the central
Parliament get more transfers-hence that the
degree of alignment should marter. Biswas
and Marjit (2000) study a similar problem for
loans from the Centre to the states which are often at
highly subsidized ratcs. Finance Commission
transfers: have mostly been immune to such criticisms.
Khemani (2003), however, shows that Finance
Commission: transfers tend to compensate
for the political bias in other wansfers. Since the
early 1990s, however, the assumption that there is a
unitary incumbent has been challenged by the large
number of coalition governments at the : Centre.
Rodden and Wilkinson (2004) argue that theories of
legislative bargaining are more suited to the current
scenario. They find that in line with this theory, states
that have powerful bargaining positions or are
pivotal in some way in the coalition receive
disproportionate allocations This is true also for states
that have a larger number of party members supporting
the central coalition from outside, even though they
are not formally members of the coalition.
The other notable feature of Indian fiscal federalism is
the interestaje inequalities in revenue capacity
and per capita expenditures: This is a natural
consequence of the huge differences in per
capita incomes between states, which are,
 moreover, increasing over time; in 1980-1,
Punjao, the richest state, had a per capita income
which Awas about three times that of Bihar, the
poorest state,
While in 1998–9 Punjab's per capita income was
five times that of Bihar. Hence, différences in the
ability to raise revenue have also increased over time.
Per.capita expenditures were 44 per cent higher than
the all-India . average in the high-income states while
they were 36 . per cent lower than the average in
low-income states in
2000-1. Part of the rationale for transfers by the Centre .....10. the
states was to reduce the horizontal imbalance,
Empirical evidence on the issue of whether
Finance Commission transfers have resulted
in lower inequality is ambiguous at best.

AMRITA
DHILLON

References
Biswas, R. and Sugata Manjit. 2000. 'Political Lobbying
and
Discretionary Finance in India: An Aspect of
Regional Influence in a Representative
Democracy', mimeo, Center
for Studies in Social Sciences, Calcuta. Dasgupta, S., A. Dhillon,
and B. Dutta. 2004. 'Electoral Goals
and Centre-State Transfers: A Theoretical
Model and Empirical Evidence from India', mimeo,
University of Warwick.

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