The new era of fiscal federalism could strengthen national unity

Context: The 15th Finance Commission (2021-2026) retained the states’ share, and its methodology of assigning weights based on population. This is likely to be a factor in the politics of federalism.

Importance of fiscal federalism in India

Linguistic pluralism, a federal structure and fiscal federalism have served us well and enabled us to succeed

At the time the Constitution came into force, some regions were endowed with more human capital, infrastructure and industrial capacity, others had abundant natural resources, and a few had very limited economies. Therefore, fiscal federalism is important for balancing equity, equality and efficiency in a country having a hyper-diverse federation.

Fiscal federalism is an important force to leverage the comparative advantage.

On the one side, the linguistic reorganization of states helped address political aspirations. On the other side, fiscal federalism has been important for the political restructuring.

Why states in India have weak fiscal capabilities?

The following reasons have resulted in India’s states to have relatively weak fiscal capabilities:

The Planning Commission was an important arbiter of how funds were shared. Central planning constrained both the market and State governments in allocation of resources.

The nationalization of banks further centralized resource allocations and aligned them to planning.

Important Institution to uphold fiscal federalism

Finance Commission

The Constitution of India created an independent, non-partisan Finance Commission to determine how fiscal resources ought to be shared among the Union and states.

It has functioned transparently, professionally and has played a fundamental role in keeping the country united. For example, politically sensitive and border states receive disproportionately larger shares of funds.

Every Finance Commission has worked with consultative and non-partisan character. Therefore, its recommendations have been accepted by the Union and states as fair. 

Measures towards Fiscal Federalism

A new era of fiscal federalism started when the 14th Finance Commission raised the states’ share of funds from 32% to 42%.

In addition to this, the Planning Commission was disbanded by the government in 2015.

Further, the GST framework has been adopted. The GST Council has given a powerful platform to the states to negotiate their fiscal interests. Therefore, the states enjoy a greater degree of fiscal autonomy than before.

What are the challenges involved?

Now the Union government has a larger role in directing expenditure through a large number of “centrally sponsored schemes” like those for education, health and rural employment guarantee.

The states are laggards in setting up state finance commissions to devolve funds to municipalities and panchayats.

State governments and local bodies have also been reluctant to raise their own revenues.

There are political considerations which prevent taxing of the richer farmers in India.

There are bureaucratic incapacities at the municipal level in terms of the collection of property taxes because “the closer the government is to the people, the more unwilling it is to raise taxes“.

Way Forward

The states have to learn how to frame fiscal policy otherwise, the fiscal balance will tilt towards the Centre.

There should be requisite deliberations on providing a permanent secretariat to the Finance Commission

The Inter-State Council chaired by the Prime Minister and comprising state chief ministers, must be upgraded into a national forum.

Source: The post is based on an article “The new era of fiscal federalism could strengthen national unity” published in the Live Mint on 06^th June 2022.