Rethink the dynamics of India’s fiscal federalism

Source– The post is based on the article “Rethink the dynamics of India’s fiscal federalism” published in “The Hindu” on 26th August 2023.

Syllabus: GS3- Government budgeting. GS2- Issues pertaining to federalism

News– The article explains the need for relook at the present system of fiscal federalism.

Why do emerging dynamics of India’s fiscal federalism need rethinking?

Fundamental shift from a centrally planned economy to a market-driven economic structure.

The conversion of a dual-tier federation into a multi-tier fiscal system following the 73rd and 74th Constitutional Amendments,

The elimination of the Planning Commission and its substitution with NITI Aayog,

The enactment of the Fiscal Responsibility and Budget Management (FRBM) Act.

The implementation of the Goods and Services Act with authority vested in the GST Council,

The widespread utilization of cess and surcharges that impact the size of the divisible pool.

Why should the system of transferring resources between different levels of government be more focused on equity?

According to Chancel and Piketty (2019), the share of total income captured by the top 1% earners in India was less than 21% in the 1930s. It dropped to 6% in the early 1980s and then increased to 22% during the period of economic liberalization.

The recent measures like tax exemptions and concessions have disproportionately favored the affluent and have reduced the available pool of resources.

Per capita income in 16 major states from 1970-71 to 2020-21 reveals an increasingly divergent pattern.

The Human Development Index across 15 states exhibits convergence during the post-reform era. When examining data since 2005, the rate of convergence has decreased with a significant negative CAGR of -2.85%.

Why is there a need for reevaluating Article 246 and the Seventh Schedule to undertake a fresh division of powers, functions, and responsibilities?

India’s political landscape has evolved from the single-party governance of the post-Independence era to a genuinely multi-party system.

The dynamics of politics, society, technology, demographic composition, and even the development approach itself have undergone substantial changes.

In the new evolving framework, numerous central legislation, including the MGNREGA 2005, the Right of Children to Free and Compulsory Education Act 2009, and the National Food Security Act 2013 place an additional burden on the individual states.

During the process of constitution-making, the issues of division of responsibilities and taxation authority was not adequately addressed. It heavily borrowed from the Government of India Act 1935, and neglected the subsidiarity principle.

73rd and 74th Constitutional Amendments provided an opportunity for reconsideration. But, no significant steps were taken. In fact, matters were complicated further by the introduction of Schedule XI and Schedule XII.

These schedules lack practical significance unless they are broken down into specific activities and sub-activities, similar to the approach adopted by Kerala and a few other states.

What are other issues related to fiscal federalism that should be considered by the Union government?

The persistent neglect in integrating the third tier of governance into India’s fiscal federal framework is a significant concern.

The lack of a consistent financial reporting system across all tiers of government presents a notable deficiency.

A comprehensive reevaluation of the off-budget borrowing practices of both the Union and the individual States is essential.

Such borrowings usually evade scrutiny and remain unreported. All financial transactions should be accounted for under appropriate budgetary allocations.

The central government should set a positive example. But, it is perhaps more culpable of resorting to off-budget borrowing than the States.

States are subject to restraint through Article 293(3) under the oversight of the Union and the Fiscal Responsibility and Budget Management (FRBM) Act. But, the Union frequently evades such checks.

The substantial use of the National Small Saving Fund (NSSF) for financing central public sector undertakings and ministries through loans is not included in the Union’s fiscal deficits.

There is also a substantial domain of unique banking arrangements involving public sector banks to facilitate cash and credit circulation outside the bounds of budgetary allocations.

It is imperative for the Union, States, and local governments to act transparently and make all off-budget transactions transparent and publicly accessible.