| Introduction: Contextual Introduction Body: Implications of raising share of net proceeds to eliminate VFI Conclusion: Way forward |
Vertical Fiscal Imbalance (VFI) refers to the mismatch between the revenue-raising capabilities and expenditure responsibilities of different levels of government. In the context of India, the Union government collects a greater share of total revenue, while the States bear a larger share of the expenditure burden. This imbalance, as noted by the 15th Finance Commission, is particularly pronounced in India, with States incurring 61% of the total expenditure but only collecting 38% of the revenue.
Implications
- Enhancing Cooperative Fiscal Federalism: Reducing VFI aligns with the principles of cooperative federalism, where States and the Union work together to promote balanced economic development. This promotes a healthier fiscal relationship and reduces friction between the two levels of government, fostering a collaborative approach to governance.
- Addressing Crisis-Driven Imbalances: As noted during the COVID-19 pandemic, crises tend to exacerbate VFIs by driving a wedge between States’ revenue and expenditure responsibilities. A reduced VFI would make States more financially resilient in the face of such emergencies, reducing the need for constant bailout support from the Union government.
- Efficiency in Expenditure: States, being closer to the people, are better positioned to understand the specific needs of their populations. The ability to plan and allocate resources without heavy dependence on central grants can also encourage better governance and accountability at the sub-national level.
- Increased Flexibility for States: The devolution of taxes from the Union to the States provides unconditional or untied funds, which allow States to allocate resources based on their own priorities and jurisdictional needs. This increases fiscal autonomy, enhancing the ability of States to respond effectively to local development challenges.
- Constitutional Efficiency: The Constitution of India mandates a division of financial duties between the Union and the States. Revenue collection is centralized with the Union for efficiency, while expenditure responsibilities are decentralized to the States to maximize the efficiency of spending on public goods and services. This decentralized expenditure approach is meant to bring governance closer to the people.
Conclusion
Increasing tax devolution to around 49%, as suggested by empirical analysis, would strengthen India’s fiscal system by enabling States to more effectively meet their responsibilities. This adjustment would foster a more balanced and efficient federal structure, improving governance and optimizing resource allocation at the State level.
