Intergenerational and Intragenerational Fiscal Equity in India

Source: The post intergenerational and intragenerational fiscal equity in India has been created, based on the article “Intergenerational equity as tax devolution criterion” published in “The Hindu” on 18th July 2024

UPSC Syllabus Topic: GS Paper3- Economy- mobilization of resources

Context: The article discusses how tax revenue from the central government is distributed among states in India. It emphasizes balancing fairness between generations and between different states’ economic statuses, suggesting changes in the criteria to ensure both current and future financial equity.

For detailed information on Fiscal Federalism in India read this article here

What is the Principle of Intergenerational and Intragenerational Fiscal Equity?

1. Intergenerational Fiscal Equity: This principle ensures that current government spending does not become a financial burden on future generations. If a government covers its expenses through borrowing, it means future taxpayers will have to pay more in taxes. For instance, during the 14th Finance Commission period, higher borrowing by states could lead to higher future taxes.
2. Intragenerational Fiscal Equity: This focuses on fair distribution of resources among different states within the same generation. High-income states, such as Maharashtra and Tamil Nadu, generate substantial tax revenue but receive fewer Union transfers, unlike states like Bihar and Uttar Pradesh, which rely more on Union money.

What Challenges Arise from Current Fiscal Policies?

1. Intergenerational Inequity: Current fiscal policies, like funding government expenses through borrowing, potentially burden future generations with higher taxes. This creates a cycle where future taxpayers bear the cost for today’s spending.
2. Disparity in State Funding: High-income states like Gujarat and Maharashtra, which contribute significantly through taxes, receive fewer Union transfers compared to their contributions. They financed 59.3% of their revenue expenditure through their own taxes, while low-income states like Bihar and Uttar Pradesh financed only 35.9% and depended heavily on Union transfers.
3. Legal Limit Breaches: Reduced Union transfers force some states to exceed their Fiscal Responsibility Act limits, risking fiscal sustainability.

What Should be Done?

1. Adjust the Tax Distribution Formula: The Finance Commission should revise the criteria used to distribute Union tax revenue, incorporating more fiscal variables that reflect actual state performance and needs. This would ensure fairer distribution between states.
2. Increase Weights for Fiscal Indicators: Fiscal discipline and tax effort should carry more weight in the distribution formula. This adjustment would encourage states to improve fiscal management and revenue collection, thus ensuring more sustainable finances.
3. Enhance Support for High-Income States: High-income states like Maharashtra, which financed 59.3% of their expenditure through their own revenues, should receive fairer Union transfers to acknowledge their contribution and prevent fiscal imbalances.
4. Legal and Fiscal Policy Reforms: Implement policies that prevent excessive borrowing and ensure intergenerational equity. This includes enforcing Fiscal Responsibility Acts strictly and adjusting policies to avoid future generations being burdened by current fiscal decisions.

For detailed information on Tax Contribution by States Needs to be Revisited read this article here

Question for practice:

Examine how current fiscal policies in India impact both intergenerational and intragenerational fiscal equity.