Rethink the emerging dynamics of India’s fiscal federalism

Indian Federalism:

1. A ‘holding together federation’ with a built-in unitary bias.
2. Dual Polity: Separate independent Govts at Centre & States.
3. Written Constitution: Powers of Centre & States clearly marked out in the form a written book.
4. Division of Powers: Powers divided into Union (100 subjects), State (61 subjects) & Concurrent (52 subjects) Lists.
5. Supremacy of Constitution: All organs of Govt at Centre & States operate within jurisdiction provided by Const. Centre can’t step over States.
6. Rigid Constitution: Provisions regarding Federal Structure of Country are difficult to amend, requiring Special Majority + Consent of States.
7. Independent Judiciary: To protect & enforce Supremacy of Constitution.
8. Bicameralism: Rajya Sabha is a permanent representation of States.
9. Federal System was adopted due to the large size of the Country & Socio-cultural diversity.

Recent changes in the Federal-Fiscal landscape:

1. Paradigm shift from a planned economy to a market-mediated economic system
2. The transformation of a two-tier federation into a multi-tier fiscal system following the 73rd and 74th Constitutional Amendments
3. Abolition of the Planning Commission and its replacement with NITI Aayog
4. Passing of the Fiscal Responsibility and Budget Management (FRBM) Act
5. Goods and Services (GST) Act with the GST.
6. The extensive use of cess and surcharges which affect the size of the divisible pool.

Issues with India’s Fiscal federalism:

1. India’s intergovernmental transfer system is failing on the aspect of ‘equity-orientation’.
   • The top 1% earners in India captured less than 21% of the total income in the 1930s which dipped to 6% in the early 1980s, but rose to 22% during the liberalisation era.
   • The tax exemptions, tax concessions and other revenues forgone has disproportionately favoured the rich and have reduced the size of the divisible pool.
2. Several pieces of central legislation have imposed extra burden on the States.
   • For instance, central acts such as Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA), 2005, The Right of Children to Free and Compulsory Education Act 2009, the National Food Security Act 2013.
3. The functional and financial responsibilities of the Panchayat Raj Institutions and municipalities has not been clearly demarcated with the passing of 73rd and 74th Constitutional Amendments.
4. The absence of a uniform financial reporting system comprising all levels of government, placing the third tier properly on the fiscal federal map of India is a major deficit.
   • Though the Constitution refers to the third tier as ‘institutions of self-government’ policymakers, experts have referred to it has ‘local bodies.’

What has to be done?

1. ‘Equity-oriented’ intergovernmental transfer system should be the norm.
   • Equity should be the main concern of the 16th Finance Commission.
   • HDI can be used as a strong candidate in the horizontal distribution of tax devolution.
   • Article 246 and the Seventh Schedule has to be revisited regarding division of powers, functions and responsibilities for a variety of reasons.
2. A new local list which specifies the functional and financial responsibilities of the Panchayat Raj Institutions and municipalities has to be carried out.
3. The third tier of government has to be properly placed on the fiscal federal map of India by devising uniform financial reporting system that includes,
   • Standard budgeting rules for all tiers
   • Introduction of the accrual-based accounting system.
4. Need to review the off-Budget borrowing practices of both the Union and the States, as they are unscrutinised and unreported. All extra-budgetary transactions have to be brought to the public domain.
   • It is a Universal norm that all income and expenditure transactions should fall under some Budget head or the other.
   • State public sector undertakings and special purpose vehicles raise resources from the markets, but their servicing burden often falls on the State government.
   • In many cases the government being the ultimate guarantor, the burden of repaying the debt also falls on the State.
   • States are disciplined through Article 293(3) by the Union through the FRBM Act, the Union often escapes such controls.
   • The National Small Saving Fund (NSSF) has been liberally utilised for extra-budgetary financing of central public sector undertakings and central ministries by way of loans which is not reflected in the Union fiscal deficits.
   • The borrowing space of States is restricted, the Union escapes such discipline.