[Answered] How has the transition from a planned economy to a market-mediated economic system impacted India’s fiscal federalism?

Since the early 1990s, India has carried out significant economic changes that have resulted in a more market-oriented approach while keeping some aspects of a mixed economy. These reforms, often referred to as the “economic liberalization” or “economic reforms,” aimed to open up India’s economy to global markets, reduce government intervention, and encourage private sector participation. This paradigm shift was indeed followed by the transformation of a two-tier federation into a multi-tier fiscal system following the 73rd and 74th Constitutional Amendments, the abolition of the Planning Commission and its replacement with NITI Aayog, the passing of the Fiscal Responsibility and Budget Management (FRBM) Act & finally the Goods and Services (GST) Act giving major changes to India’s fiscal federalism.

How has this transition impacted fiscal federalism?

• State autonomy: State governments now have more freedom to create and carry out economic policies as a result of economic liberalization. This is also visible in the implementation of important programs like MGNREGA, RTE, & Food Security Act. There is also a demand to shift education from Concurrent to the State list.
• Devolution of fiscal powers: While states have gained more autonomy vis-à-vis Central Government, there is a lack of autonomy for local government institutions vis-à-vis state governments. There is a serious need to give more powers to third-tier institutions based on the 3F (Functions, Funds, Functionaries).
• Tax reforms: The introduction of the Goods and Services Tax (GST) in 2017 was a major step in fiscal federalism. It replaced a complex web of indirect taxes levied by both the central and state governments, streamlining the tax system and enhancing revenue collection efficiency.
• Disparity among states: Some states were better positioned to take advantage of the new economic opportunities, while others experienced difficulty in adjusting to the changing economic landscape. Economic reforms contributed to growth but also raised worries about growing economic inequities across states. This can be seen in the analysis of the Human Development Index (HDI) & per capita income data of states.

Conclusion:

The responsibility of balancing fiscal federalism rests on the mandate of the 16 Finance Commission which should start by constituting a uniform financial reporting system comprising all levels of government. There is a greater need to review the off-budget borrowing practices of both the Union and the States to maintain fiscal discipline. Finally, 16 FC should ensure that equity and HDI should be considered in the horizontal distribution of tax devolution.