Fiscal Federalism: Addressing the real deficit

The impact of tax reforms in India, the latest being the introduction Goods and Services tax, calls for deeper analysis from the point of view of India’s federal structure. The book  Challenges to Indian Fiscal Federalism sights empirical evidence for centralising tendencies in the fiscal domain which could impact state finances and calls for a discussion on it.

The book Challenges to Indian Fiscal Federalism is a humble attempt to place in the public domain the empirical evidence for centralising tendencies in the fiscal domain. The book is to look at inherent centralising tendencies in our polity which has been accentuated by the political actions of successive Union governments.

The overuse of Article 356 of the Constitution, which empowers the Centre to take over administration of a state upon perceived breakdown of the constitutional machinery is the best example of this. The office of the Governor acting against the advice of the council of ministers is yet another example, which has led to interventions from the apex court. The landmark judgement in the case of SR Bommai and more recently the in the case Lt. Governor of Dehli are a result of the intrusions into political federalism. It is in this broad context of narrowing federal tendencies in the political arena that the book attempts to underscore the challenges faced by federalism in the fiscal realm.

The vertical fiscal imbalances, which arise from relatively lower revenue mobilising powers and higher expenditure obligations of the states via-a-vis those of the Centre are to be ameliorated by tax transfers from the Centre. The book discusses this aspect in detail and draws the conclusion that the imbalances have been on the rise in the recent years. It is pertinent to note that this has happened despite the increase in the share of central taxes devolved to the states by the 14th Finance Commission.

The constraints imposed by the Fiscal Responsibility Acts and their impact on state finances are a major challenge to fiscal federalism. While the Centre has deviated from the deficit targets without any consequences, the states have been forced to adhere to deficit targets in the face of disincentives like withholding of grants, non-granting of debt relief and other conditionalities suggested by the Finance Commissions.  The book notes that the fiscal consolidation of the government sector has placed an asymmetric burden on the states.

The scenario after the imposition of Goods and Services Tax (GST) reveals that the new tax reform has been implemented without taking into consideration the principle of revenue neutrality. The states whose 44 per cent of the taxes were subsumed in GST as against 28 per cent of that of the Centre were expected to be given 60 per cent share in the GST rate. But states have got only 50 per cent share in GST rates. The resultant revenue loss to the states will further increase the vertical fiscal imbalances.

Besides these major challenges, the book also analyses the likely impact the terms of references of the 15th Finance Commission, the fiscal inequities between the states and the position of the local governments in the context of Centre-state relations.

The suggestion made by the authors is that there needs to be substantial corrections to move on to a vibrant, federal and democratic polity. It is hoped that the discerning  readers would critically look at the theme and the findings and enrich the discussions in this topic of contemporary relevance.

(The writer, a commentator on polity, is one of the co-authors of the book Challenges to Indian Fiscal Federalism)