IMPACT OF FISCAL FEDERALISM IN INDIAN ECONOMY

ECONOMICS

SUBMITTED TO:
Mr. Abhishek Sinha

Submitted by:
AVINASH SINGH
2015016
III SEMESTER
DAMODARM SANJIVAYYA NATIONAL LAW UNIVERSITY
VISAKHAPATNAM

ACKNOWLEDGEMENT:

I have taken efforts in this project. However it would not have been possible without the kind support and
help of many individuals. I would like to extend my sincere thanks to all of them.
I am highly indebted to Mr. Abhishek Sinha sir for his guidance and constant supervision as well as for
providing necessary information regarding the project.
I would like to express my special gratitude and thanks to my friends for giving me such attention and time
and helping me in developing the project and people who have willingly helped me out with their abilities.

TABLE OF CONTENT:
Acknowledgement
Table Of Content
Abstract
Synopsis
1. Fiscal Federalism in India
2. Evolution of Fiscal federalism
3. Fiscal Imbalances in Indian federalism
4. Constitutional provisions for distribution of
revenues
5. Fiscal Decentralization
6. Finance Commission in India
7. Quantum of Fiscal transfers
8. Macro Political Environment
9. Exploration for Reforms
Conclusion.
References

OBJECTIVE OF THE STUDY:

The objectives of fiscal policy differ from country to country and from situation to situation. The
government may increase public expenditure or it may reduce taxes to stimulate investment. This would
reduce the unemployment and increase demand. There are four objectives of fiscal policy are equity,
allocation of resources, economic stability and full employment, and growth.

SCOPE OF THE STUDY

Fiscal federalism in India unlike in many rich countries has to satisfy the competing demands to deliver a
number of essential and basic socio-economic services. As a paramount objective, fiscal federalism is
expected to enable the national and sub-national governments to operate in such a way that leads to
efficiency in the use of resources - not only in terms of the quality of services provided by the various
levels of government but also in terms of creating the environment in which all economic agents use
resources efficiently.
HYPOTHESIS:
'Fiscal federalism' is a set of principles that can be applied to all countries attempting 'fiscal
decentralization'. In fact, fiscal federalism is a general normative framework for assignment of functions to
the different levels of government and appropriate fiscal instruments for carrying out these functions.
RESEARCH QUESTION:
(a) How are federal and non-federal countries different with respect to 'fiscal federalism' or 'fiscal
decentralization'?
(b) How are fiscal federalism and fiscal decentralization related (similar or different)?

1. IMPACT OF FISCAL FEDERALISM IN INDIAN ECONOMY

Like in other countries, the fiscal dimensions of federalism are a reflection of the economic federal
structure in India. The traditional subjects of concern of fiscal federalism, such as the assignment of taxes
and responsibilities as well as the correction of vertical and horizontal imbalances, continue to remain
important in India. Devolution of taxes and duties still constitutes the most significant dimension of fiscal
federalism in India.

Fiscal federalism in India unlike in many rich countries has to satisfy the competing demands to deliver a
number of essential and basic socio-economic services. As a paramount objective, fiscal federalism is
expected to enable the national and sub-national governments to operate in such a way that leads to
efficiency in the use of resources - not only in terms of the quality of services provided by the various
levels of government but also in terms of creating the environment in which all economic agents use
resources efficiently.
The economy environment is important in determining contours of fiscal federalism. After Independence,
there was a single and same party rule at the Centre and in almost all states for many decades. There are
now telltale signs that India is moving away from an era of cooperative federalism towards competitive
federalism, due to multi-party polity, and predominance of regional parties at the state level, and coalition
governments at the centre. The existence of competition brings-in the importance of transaction cost of
coordinating policies and their implementation (a) vertically between different levels of government and
(b) horizontally between different units within each of the levels. Many challenges, therefore, lie ahead for
fiscal federalism in the country. Bulk of literature on federalism in India had focused on economic aspects
of fiscal federalism. There is a little work done in the area of environmental policy and its influence on
intergovernmental financial relations in India. Within the context of Indian Federalism, what remains
important is to take into account the social diversity in a general sense and the diverse ways in which each
member state is able to relate to the federal system as a whole and to other member states. The existing
cultural, economic, social, environmental and political factors combining to produce asymmetrical
variations in the country, if not handled properly, have the potential to affect harmony within the federal
structure of the country.

2. EVOLUTION OF FISCAL FEDERALISM

The history of fiscal federalism in modern India goes back to the Government of India Acts of 1919 and
1935. While the Act of 1919 provided for a separation of revenue heads between the Center and the
provinces, the 1935 Act allowed for the sharing of Centers revenues and for the provision of grants-in-aid
to provinces. The salient features of Government of India Acts of 1919 and 1935 are provided as:
2.1 MAIN FEATURES OF THE GOVERNMENT OF INDIA ACT, 19191

1 Government of India Act, 1919

(1) Relaxation of Central control over the Provinces: The Act of 1919 made a separation of the subjects
of administration and sources of revenue into two categories-Central and Provincial. The Provinces could
run the administration with the aid of revenues they themselves raised. Provincial budgets were separated
from the budget of the Government of India.
(2) Diarchy in the Provinces: The Provincial subjects were divided into transferred and reserved
subjects. Transferred subjects were to be administrated by the Governor with the aid of Ministers
responsible to the Legislative Council in which the proportion of elected members was 70 percent.
Reserved subjects were to be administrated by the Governor without any responsibility to the Legislature.
(3) The Indian Legislature: It was made more responsible and bicameral, but on a communal and
sectional basis. The diarchy was impracticable and devoid of any real substance. The Governor had all the
powers and the introduction of ministerial government over a part of the Provincial sphere was only an
empty shell and was, as such, a failure. Even though subjects were divided, the Central Legislature retained
the power of legislation for the whole of India. No popular responsibility was introduced at the Centre and
the Governor General-in-council continued to remain responsible only to the British Parliament through the
Secretary of State for India.

2.2 THE MAIN FEATURES OF THE GOVERNMENT OF INDIA ACT, 19352

(i) Federal Scheme: Under all the earlier Acts, the Government of India was unitary, while the Act of 1935
prescribed a federation, taking the Provinces and the Indian States as units. It was proposed to unite the
Provinces and the India States into a federation under the Crown. This involved the breaking up of the
unitary State into a number of autonomous Provinces which were to derive their authority directly from the
Crown, and then building them up into a federal structure, in which both the federal and Provincial
governments would get definitely demarcated powers by delegation from the Crown. The federal structure
envisaged by this Act never came into being, because it was optional for the Indian States to join, and they
never gave their consent.

2 Government of India Act, 1935

(ii) Provincial Autonomy: Though the part relating to the federation never came into effect, the relating to
Provincial autonomy was given effect to from April 1937. To this extent, the Government of India assumed
the role of a federal government vis-vis the provincial government, although the Indian states did not
come into the fold to complete the federal scheme. The Act of 1935 retained the control of the central
government over the provinces in certain spheres requiring the Governor to act without ministerial advice
and through him, of the Secretary of State.
(iii) Diarchy at the Centre: The executive authority of the Centre was vested in the Governor General (on
behalf of the Crown), whose functions were divided into:
(a) Reserved subjects- Defence, external affairs, etc., left to the Governor General in his discretion; and
(b) Other than reserved subjects-in which the Governor General was to act on the advice of a Council of
Ministers.
In fact, no Council of Ministers came to be appointed; and the old Executive Council provided by the Act
of 1919 continued to advice the Governor General until the Indian Independence Act, 1947. The executive
authority of the Act of 1935 was applied as between the Central government and the Provinces. This is of
special interest in view of the fact that the States, proceeds largely on the same lines. A three-fold division
was made in the Act of 1935: Federal List, Provincial List and Concurrent List. The allocation of residuary
powers of legislation in the Act was unique in the sense that it was not vested in either the Central or
Provincial Legislature, but empowered the Governor to authorize either the federal of the Provincial
Legislature to enact a law with respect to any matter which was not enumerated in the Legislature Lists.
(iv)Non-Sovereign character of the Legislature: The legislature powers of both the Central and
Provincial Legislatures were subject to various limitations and neither could be said to have possessed the
features of a sovereign legislature.
(v) Federal Court: Consistent with the federal scheme, the Act set up, for the first time, a Federal Court for
India. The Federal Court had an original jurisdiction to determine disputes between the units of the
federation inter se and it was also the Appellate Court on constitutional questions, Appeal, however, lay
from the decisions of the Federal Court to the Privy Council until such appeal was abolished by the
enactment of the Abolition of the Privy Council Jurisdiction Act, 1949.
After independence, the Indian Constitution that came into existence in 1950 is widely known as basically
federal in nature, but with striking unitary features, owing to the circumstances of the times when

unity and integrity of the country was of prime concern3. Fiscal relations in India had evolved over time
through political, institutional and functional changes within the ambit of the provisions of Indian
Constitution. The Finance Commission had played an important role in this evolving structure because
resource sharing, based on constitutional division of functions and finances between the Centre and states,
is a critical element in the Indian federal system.
The Indian Constitution has not only provided a frame work for social and political development but also
established the national ideals and, laid down the manner in which they were to be pursued. The members
of the Constituent Assembly skillfully selected and modified the provisions they borrowed and applied
to their task two concepts accommodation and consensus. Accommodation was applied to the
principles to be embodied in the Constitution.
Consensus was the aim of the decision making process, the single most important source of the constituent
Assembly effectiveness.4 While the spirit of accommodation has been evident not only in the finalization of
the provisions of Constitution but also in the manner in which Indian union and the constituent states have
discharged their responsibilities of serving an ever increasing population within the democratic framework
of governance. The profile of Federal India has undergone significant changes over the last six decades,
with the population increasing from 36.10 million 1951 to 1027 million in 2001, and with the number of
states emerging in 1956 in a major way and at subsequent points of time in a minor way.
3. IMPACT OF FISCAL IMBALANCES IN INDIAN FEDERALISM
Fiscal imbalance refers to the mismatch between own revenue raising capacity and expenditure needs at
different governmental units. In an abstract sense, this implies the gap between revenue and expenditure
when both revenue sources and functions are allocated between various units of the government optimally.
However, empirical estimates of fiscal imbalances are difficult to derive on the basis of such definitions,
for, estimates of revenue capacity or expenditure needs in an absolute sense will depend heavily on the
relevant value judgements made and in practice, it is difficult to find an allocation of revenue sources and
responsibilities which is strictly optimal in any sense. Thus, measurement of fiscal imbalances involves, of
necessity, actual elements of federalism as opposed to normative ones, although the very concept of fiscal
imbalance has a built-in normative consideration; the general presumption would be that the less of
imbalance than better.
3 Basu, 1980
4 Granville, 1966.

Usually, two types of fiscal imbalances are discussed in the literature. The imbalances at different levels of
the government (inter-governmental) are known as vertical fiscal imbalances, while those at different units
at the same level of government (inter jurisdictional) are known as horizontal fiscal imbalances. Although
these two concepts are identifiable by themselves, they are, except under very special circumstances,
related5. If the distribution of revenue sources and expenditure responsibilities between the Centre and the
States is such that the Centre raises more than it spends while the States spend more than they raise, the
extent of this vertical fiscal imbalance can affect the horizontal fiscal imbalance (i.e., between different
States) through the non-neutral incidence of Central revenue and expenditure package. Only when the
benefits from the Central expenditure (or grant) exactly match the tax (revenue) collections in each State is
the incidence of Central fiscal policy neutral.

VERTICAL IMBALANCE

Vertical fiscal imbalance is usually given primary importance in the discussions of fiscal imbalances,
probably because it serves to focus on the most lively issue of federal finance that of mismatch in the
assignment of taxing powers and expenditure responsibilities. Adequacy and elasticity are the essential
elements of federal finance. Adequacy implies sufficient resources for discharging constitutional
responsibilities and elasticity implies an expansion of resources in response to the growing needs of
Government. The practical effect of the division of tax powers has been to deny both these characteristics
in the case of states in India.6 A vertical imbalance between the Centre and states is built into the
Constitution by the provisions relating to powers of taxation. This arises, not out of any consideration of
making the centre stronger, but out of the desire to build a common economic space in the country and out
of an apprehension that with more powers the states may put up barriers within this space.
The vertical imbalance is further accentuated by the assignment of several responsibilities involving the
public expenditure to the states on the grounds that tiers of government nearer to the people would be more
sensitive to their needs and thus be better able to discharge such responsibilities. Since states differ in their
resource endowments, levels of development and standards of delivery of public services, there are sharp
horizontal imbalances among the states in India.
5 Estimates o f relative revenue capacity and expenditure needs, however, are frequently made. See India (1989), for an
example in the Indian context.

6 Vithal and Sastry, 2001

HORIZANTAL IMBALANCES

Apart from the number of reasons for the existing vertical imbalance in India outlined above, significant
horizontal fiscal imbalance provides an important reason. From the national point of view, it has been
considered improper to allow the persistence of large horizontal imbalances, and these have been sought to
be corrected through equalising transfers from the Centre, which automatically imply some amount of
vertical imbalance. The horizontal imbalances have in turn arisen mainly from inter-State disparities in
revenue capacity and effort as well as in expenditure needs.
Out of the 25 States in the Indian federation, 15 are relatively homogeneous while 10 hill States (seven
North-Eastern States, Sikkim, Jammu & Kashmir and Himachal Pradesh) form a distinct category,
generally grouped together as Special Category States. The latter group is characterised by small
industrial sectors and largely unorganized economies. At the same time, due to the geographical and
demographic factors, the unit cost of providing various public goods and merit goods is relatively high in
these States. As a result, their revenue capacity is low compared to their high per capita public
expenditures, leading to fairly high degrees of fiscal imbalance. Most of these States are also located on the
national boundary, which has historically resulted in frequent bouts of social and economic destabilisation;
this has also led to increased fiscal dependence on the Centre. Even the 15 relatively homogeneous States
exhibit wide disparities in the level o f economic and social development, irrespective of the indicator(s)
chosen. Naturally, their fiscal situation also shows wide divergences.
Inter-governmental transfers
In order to correct built-in vertical and horizontal imbalances for an even and equitable development of the
entire country, the main instrument for achieving this is fiscal transfers from the Centre to states through
different channels and the mechanisms as provided in the Constitution. Fiscal transfers to the third tier of
government through subsequent Constitutional Amendments (73rd and 74th) had also been envisaged in
India. Accordingly, there are both mandatory and enabling provisions facilitating a wide ranging transfer of
resources from Union to states.

4. CONSTITUTIONAL PROVISIONS FOR DISTRIBUTION OF REVENUES BETWEEN THE

UNION AND THE STATES IN INDIA7
Article 268: Duties levied by the Union but collected and appropriated by the States.
Article 268 (A): Taxes on services shall be levied by the Government of India and such tax can be
collected and appropriated by Government of India and the States. (88th Amendment)
Article 269: Taxes levied and collected by the Union but assigned to the States.
Article 270: Taxes levied and collected by the Union and distributed between the Union and the States.
Article 271: Surcharge on certain duties and taxes for purposes of the Union.
Article 272: Taxes which are levied and collected by the Union and may be distributed between the Union
and the States.
Article 275: Grants from the Union to certain States.
Article 276: Taxes on professions, trades, callings and employments.
Mechanism of Transfers
Over the last six decades, an overarching institutional framework had emerged to deal with Centre-state
financial relations in India. The main pillars of this frame work are:
(a) Finance Commission appointed periodically as per Article 280 of the Constitution of India, intended to
address the vertical imbalance in financial resources between the centre and states and to address the
horizontal distribution of resources among the states.
(b) Planning Commission set up by a Resolution of the Government of India dated 15th March 1950 to
make an assessment of the material, capital and human resources of the country, and to formulate a plan for
effective and balanced utilization of the countrys resources.
(c) National Development Council set up in August 1952 to strengthen and mobilize the effort and
resources of the nation in support of the Five year plans.
The financial provisions of the Constitution are in accordance with what experts would consider acceptable
principles for a federal constitution and a desirable attribute of inter-governmental tax power assignment.8

7 The Constitution of India.

8 Bagchi, 2001

However, it is the actual working of the scheme that has revealed deficiencies that seriously detract from
much of its supposed merits. It cites the under utilization of Article 269 by the Union Government, the
abridgement of the scope of Article 275, and, consequently, the extensive use of Article 282 by the Union
to make extensive grants to the states as examples of the original constitutional scheme being distorted in
actual practice over the years.
It is the combination of all three agencies, namely, the Finance Commission, Planning Commission and the
various Ministries of Government of India, that has taken, over several years, qualitatively significant and
quantitatively demanding decisions resulting in an increasing level of transfer of resources from the Centre
to states.

Distribution among the states

In the approach to horizontal devolution, each of the previous Finance Commissions has come up with its
own formula, with changes in criteria adopted and with the assignment of weights to different criteria for
determining the share of individual states in the total share of Central resources. The choice of criteria and
the weights assigned by each Commission for the distribution of income tax and union excise duties had
regularly provoked not only reaction from the state governments but also invoked critical comments from
academics and public finance experts. The relative importance to be attached to equity in distribution and
efficiency in utilization of resources in determining the respective shares of various states in federal
transfers has become a critical factor. Resolving the tension between equity and efficiency remains a
fundamental challenge in public policy.9

5. FISCAL DECENTRALISATION

The decentralisation theorem demonstrates that provision of public services by sub-Central governments, in
the absence of scale economies, can result in significant welfare gains as compared to the centralised
9 Bagchi, 2001

solution of uniform supply.10 The more varied is the demand for public services across different
jurisdictions, the larger are the welfare gains from fiscal decentralisation. Decentralised provision of local
public goods can supply to the varying preferences of people better and thus enhance social welfare. It is
also demonstrated that the welfare gains from decentralisation are inversely related to the price elasticity of
demand for public services. Welfare gains can also accrue from the wider choice implicit in the different
tax-benefit packages offered by different jurisdictions.
When the choice set is wider, individuals can vote on their feet for the preferred communities. Further, the
wider choice reduces the welfare cost implicit in the bundling (provided on take it or leave it basis) o f
public services. However, when there are significant scale economies or when sub-Central provision o f
public services involves transaction and organisational costs, the assignments should be done so as to
maximise the net welfare gains.
The fiscal decentralisation on the basis of tripartite division of governmental functions makes an implicit
assumption of a market determined allocational process where the governmental interference is confined to
the cases of market failure. However, when the government itself directs the allocation of resources, as it
happens in a centrally planned or a public sector dominated economy, the issue of decentralisation is
pushed to the background. The social engineering of allocating resources according to the priorities laid
down by the planning agency does not recognise consumer choice and fiscal decentralisation implicit in the
market economy. However, this is not to mean that fiscal decentralisation has no role in planned economy
whatsoever. Surely, decentralisation in a planned economy can be useful in providing informational input
and thus economise on informational costs as also in implementing the programmes efficiently. 11 In other
words, the degree of decentralisation desired in an economy and the assignment of tax, expenditure and
regulatory powers following from it depend upon the envisaged role of the government vis-a-vis the market
in allocating resources.

6. FINANCE COMMISSIONS IN INDIA: A REVIEW

10 In the traditional literature on fiscal federalism, intergovernmental transfers have been justified mainly to ensure equal
treatment of equals (or horizontal equity) with regard to their private and public consumption levels (Buchanan, 1950, Boadway
and Flatters, 1983). The competitive federalism literature, however, justifies such transfers as an instrument to bring about
competitive equality among the jurisdictions (Breton and Fraschini, 1992).

11 (Bagchi and Sen, 1991).

After more than six decades of functioning, Finance Commissions of the past, have in their approach to
transfer of Central resources to the states have appraised the quantitative and assessed the qualitative
aspects of public expenditure. Having experienced thirteen Finance Commissions in India, it could be
concluded that the mechanisms envisaged in the Constitution have proved adequate for dealing with the
consequences of the asymmetry of resources between the Centre and the states. The Commissions did not
feel constrained by the terms of reference given by the Centre, and derived authority from the constitutional
provisions to go beyond these terms whenever they felt that an equal treatment between the Centre and the
states required this. They excluded the plan expenditure from their purview, not because they accepted this
as a constraint imposed by the Constitution or the terms of reference, but because they recognized the
complementary role of the Planning Commission in the plan process.12
The broad approach of the Commissions has been to follow the principles of justice in what is called the
vertical division of resources between the Centre and the states; while in the horizontal distribution of these
resources among the states equity has to be taken into consideration in view of the disparate levels of
development of different states. For this purpose, the two main instruments they resorted were: (a)
progressive formulae for the distribution of the divisible pool and (b) grants-in-aid under Article 275. The
Commissions and the states have been in agreement that the more important instruments of transfer from
the Centre to the states should be the devolution of taxes, with the grants-in-aid playing a residuary role.

7. THE QUANTUM OF FISCAL TRANSFERS

The Fiscal Transfers of Federal System, as they now stand to cover:
(a) State share of Central Taxes and duties
(b) Non Plan grants and loans
(c) Central assistance for State plans
(d) Assistance for Central sector and Centrally Sponsored Schemes.
The sum of the above transfers makes up to Gross Transfers. The Central Government recovers its loans
and advances including interest, due from the states, which gives rise to Net Transfers. The details of the
total transfer of financial resources from centre to states as percent of gross revenue receipts of the Centre
in recent years. It shows average transfers from Centre to states as percentage of gross revenue receipts of
the Centre coinciding with various Finance Commissions.

12 (Srinivasan, 2002).

Total transfers through Finance Commission varies from 22.77 (VIII FC) to 26.20 percent (XII FC), while
total transfers after taking into consideration other transfers varies from 35.27 (XI FC) to 40.33 percent (IX
FC). Finance Commission transfers include share in Central Taxes as well as grants. Similarly, other
transfers consist of grants through Planning Commission and non-plan grants (Non-statutory). Planning
Commission grants vary from 10.57 (X FC) to 14.49 percent (IX FC). The transfers recommended by
successive finance commissions have increased enormously.
The level of transfers, whether viewed in gross or net terms show that over the decades the transfers, from
Central to the states have been increasing in absolute terms, but the states have a different perception on
this as they feel that it is not only the sums in all but also the manner of transfer, whether statutory or
discretionary, and whether as a share of central revenues or of state expenditure.
One major area of criticism of fiscal federalism in India is the downfall in the relative share of resources to
states. Under the Eleventh Plan, a further reduction in the share of resources to states has been envisaged,
with the central assistance coming down from 26 percent to 23 percent. With the untied funds being
constantly reduced, the dependence of states on the Centre has been increasing. Growing disparities in
fiscal capacities and levels of services among states upset this stability as widening disparities require
larger and more progressive transfers.
The Criteria For Devolution Of Taxes And Grants
As regards the determination of the inter se shares of the states, the basic aim of the finance commission
transfers in the past has been to correct the differentials in revenue capacity and cost disability factors
inherent in the economies of states and foster fiscal efficiency among the states. The criteria used in the past
for these purposes can be grouped under:
(a) factors reflecting the needs, such as population and income, measured either as distance from the
highest income or as inverse;
(b) cost disability indicators such as area and infrastructure distance; and
(c) fiscal efficiency indicators such as tax effort and fiscal discipline.
In so far as devolution of central taxes and grants are concerned, population is the basic indicator of need
for public goods and services and it ensures equal per capita transfers across states. However, the overall
population criterion does not take into consideration effective family welfare measures adopted by various
states. The result being the states those are tardy in controlling their population gets unduly rewarded.
Among the criteria used for correcting differential fiscal capabilities for enabling poorer states to meet
better the needs for public goods services, per capita income distance is the preferred indicator.

In so far as devolution of central taxes and grants are concerned, population is the basic indicator of need
for public goods and services and it ensures equal per capita transfers across the countries. In differential
fiscal capabilities for enabling poorer states to meet better the needs for public goods services, per capita
income distance is the preferred indicator.
The use of geographical area of a state as a criterion for determining its share emanates from the
additional administrative and other costs that a state with a larger area has to incur in order to deliver a
comparable standard of service to its citizens. The Finance Commissions recognize that the costs of
providing services increase with the size of a state, but only at a decreasing rate. Similarly, the State
Finance Commissions use area and remoteness as criteria for financial devolution from the state
governments to rural and urban local bodies.
The index of fiscal discipline was proposed by the Eleventh FC with a view to providing an incentive for
better fiscal management and was defined as improvement in the ratio of own revenue receipts of a state to
its total revenue expenditure in a reference period in comparison to a base period. This index had also been
accepted and followed by the subsequent Finance Commissions.

8. MACRO POLITICAL ENVIRONMENT

The Constitution of India had ushered a Union of States, giving the nation a Federal character even while
several features appeared to be those of a unitary state. The democratic framework sustained through
regular elections to the Union Parliament and State Assemblies has brought India credit in the comity of
nations, but the history of Federal Republic that came into existence in 1950 has not been without
challenges. The spirit of federalism has however been kept alive, overcoming stress and strain inevitable in
a nation marked by economic, social, political and cultural diversity.
It would be prudent to say that the fiscal federalism in India has withstood many changes in the political
environment. However, the political history of the past sixty plus years in the country is testimony to the
fact that multi party coalitions are here to stay both at the centre and state levels. There are also increasing
trends that the same party or coalition may not rule at the centre and the state. The differences in political
ideologies, is expected to lead to hard time for fiscal federalism in the country as charges of favoritism and
neglect will be hurled frequently and with greater intensity. It is also important to put environmental issues
sufficiently along with social and economic issues on the radar screen of political process in India. The past

experience of fiscal federalism brings testimony to the facts that equity considerations had often preceded
over efficiency considerations in resource allocations over a period of time.
9. EXPLORATIONS FOR REFORM
The preceding discussion shows that fiscal federalism in India had a positive impact on the performance of
the public sector and the Indian economy in the initial period of planning covering the first two plan
periods. Unfortunately, the growth momentum that the economy had acquired as a result did not last. The
country moved on a slow growth path in the next twenty years. Growth picked up in the eighties but the
chronic imbalances that had developed in the economy threatening stability culminated in the crisis forcing
major reforms. Four basic weaknesses of the fiscal federalism as practised in India that seem to have
dampened the growth performance of the economy are:

Over-centralisation of economic policies and attempt by the centre to take on too much and micromanage the economy by intruding into areas assigned to the states in the constitution, stifling local

initiatives and weakening accountability of lower level governments.

Failure to ensure the development and smooth functioning of a common market in the country and

prevent its segmentation through fiscal and quasi-fiscal actions of governments at both levels.
Faulty design of intergovernmental transfers creating perverse incentives for fiscal behaviour of

recipient governments.
Inadequate central oversight over states' borrowing resulting in the problem of subnational debt and
deficit.

Reforms will be needed on a wide front if these weaknesses are to be removed. However, a few suggestions
may be offered.
First, the scheme of assignment of functions and powers to different tiers of government as contemplated
in the constitution should be respected in letter and spirit, with only such modifications as may appear
needed to correct the deficiencies and the negative externalities that have surfaced over the years in their
operation. The centre should disengage from functions that are better performed at the lower levels of
government. The tendency on the part of the centre to micro-manage the economy should cease. The CSSs
should be compressed to only a few that represent truly national interests that the states may not be in a
position to look after.
Secondly, assignment of tax powers needs a fresh look. For SNGs to be accountable and fiscally prudent it
is desirable that as far as possible they can meet their expenditures out of revenues they can raise on their

own at least at the margin. This is particularly important in the context of the constitutional recognition of
the third tier of governments, as most of them lack any substantial revenue sources of their own.
10. CONCLUSION
Ultimately, in implementing economic reforms needed to push the economy forward there is no alternative
but to reform the fiscal institutions of the federal system and the task needs to be faced upfront by the
country. These reforms acquire further urgency with the tensions inherent in federal systems coming under
increasing strain as modern technology demolishes frontiers and the world economy gets globalised,
eroding the powers of nation-states on the one hand and of their subdivisions on the other to pursue
independent policies of their own.
Federalism in India as everywhere has to face the awesome challenges of the new millennium. To maintain
an appropriate balance in the relationship between the centre and the constituent units in a federation. The
federal structure needs perpetually to be altered and mended to cope with changing environment and
emerging challenges.
However, the one cardinal reality that should never be lost sight of is that federalism is the only possible
form of government for a linguist country like India. For the federal structure to be stable and flexible,
attention of both experts and the wider public is imperative all the time.