[Yojana March 2023 Summary] Towards cooperative fiscal federalism – Explained, pointwise

Introduction

India is moving towards cooperative fiscal federalism by giving more money and power to state governments and decentralising its finances. Now, states get their share of taxes based on a formula instead of a grant, which gives them more spending freedom and flexibility. 

In the 2023–24 Union Budget provided an Effective Capital Expenditure of INR 13.7 lakh crore (This includes provision made for the creation of capital assets through Grants-in-Aid to States). This move shows that the Union government is serious about cooperative fiscal federalism and giving states financial freedom. 

What is fiscal federalism? 

Fiscal federalism refers to fiscal relations between various government units, which in the Indian context means the Union Government and the State Governments. Both tiers of government need to possess adequate financial resources to discharge their respective responsibilities enshrined in the Constitution effectively.  

What are the constitutional provisions that encourage cooperative fiscal federalism? 

• Article 246, Article 246A and the Seventh Schedule of the Constitution delineate taxation powers between the Centre and the States.  
• But the distribution of fiscal power has a centripetal bias with more buoyant tax areas assigned to the Union. The State governments, on the other hand, have more expenditure responsibilities for providing core public services. 
• However, the resources mobilised by the Union Government are not meant to be used exclusively for Union activities.  
• In India, the Union and the States together form an organic whole for the utilisation of these resources. So, the Constitution makers have very intelligently provided a mechanism to correct the fiscal imbalances through the Finance Commission. 

Finance Commission 

The President of India establishes a Finance Commission after every five years under Article 280 of the Constitution. The Commission makes recommendations on distribution of net proceeds of central taxes between the Centre and the States.

The Commission can also a) suggest the principles on which grant-in-aid of revenues, out of the Consolidated Fund of India, should be given to the States, b) corrects the horizontal fiscal imbalances due to States’ varying capacities, costs needs, and efficiency in delivering services. Fifteen Finance Commissions have been constituted so far. 

What are the recent steps taken to promote cooperative fiscal federalism?

The new India is ushering in a radical shift towards cooperative fiscal federalism. After 2014, the government of India repeatedly emphasized the pivotal role of state governments, calling them “drivers of transforming India”. States are advised to “imbibe the spirit” of cooperative federalism. To encourage cooperative fiscal federalism, the Indian government has taken a number of steps.   

Marked shift in fiscal decentralisation: 

• Following the recommendations of the 14th and 15th Finance Commissions, the Indian government gradually increased the amount of money transferred from the Union to the States each year. Annual transfers from the Union to the States, for example, have climbed from 4.7% of GDP in the fiscal year 2013-14 to 6.7% of GDP in updated forecasts for the fiscal year 2021-22.  
• Now, the States have access to the higher central resources. This gives individual states more freedom and liberty in spending expenses based on their priorities.  
• Changes in fiscal architecture have also resulted in significant changes in the style of planning and design of fiscal transfers.

NITI Aayog, a harbinger cooperative fiscal federalism: 

• The Government of India, in 2015, abolished the Planning Commission and constituted NITI Aayog. The Aayog has become a proponent of cooperative federalism.  
• It has provided a platform where States act together in the national interest and thereby fostering cooperative federalism.  
• A corollary to the abolition of the Planning Commission was removing the distinction between Plan and Non-Plan expenditure from 2017-18. This was replaced by the universally accepted practice of classifying expenditure as revenue and capital. 

Rationalisation of Centrally Sponsored Schemes: 

• This was done based on the recommendations made by a Sub-Group of Chief Ministers constituted by NITI Aayog. The Union Government in 2016-17 effected a major rationalisation of the Centrally Sponsored Schemes (CSS). The rationalisation was a long pending demand of the States.  
• The number of CSS was reduced to twenty-eight umbrella schemes, consisting of six core of the core’ schemes, twenty core schemes and two optional schemes. 
• Further, the medium-term framework for CSS and its sunset dates were made co-terminus with the Finance Commission cycle.

Introduction of GST: 

• The implementation of the Goods and Services Tax (GST) was one of the most significant structural adjustments in the indirect taxation system, substantially redefining federal fiscal relations. The GST has promoted cooperative fiscal federalism since its inception  (July 1, 2017).  
• States and governments have been awarded a weighted average of two-thirds of the total GST Council votes.  
• India has chosen a dual GST framework. Hence, goods and services are subject to two levies: the central GST and the state GST. GST has subsumed several central and State taxes.   
• It has also increased the states’ taxing ability, providing them with a larger revenue base. 

Cooperation to boost capital expenditure in States: 

• The COVID-19 pandemic had a devastating impact on economies globally. This has led to a decline in state revenue collection and a surge in demand for revenue expenditure. This has resulted in a decline in state capital expenditure, which is essential for economic growth. 
• So, in the true spirit of cooperative fiscal federalism, the Union government developed an innovative scheme called “Special Assistance to States for Capital Expenditure“ in 2020–21, which provided interest-free loans to States for capital projects, ongoing capital projects, and clearing pending bills, with full flexibility in project selection. 
• On the demand of states, the scheme continued in 2021–22 with an allocation of Rs 15,000 crore, and in 2022–23, it was expanded and renamed the “Scheme for Financial Assistance to States for Capital Investment,” with an allocation of Rs 1 lakh crore, including Rs 20,000 crore for citizen-centric reforms. 
• The state chief ministers and finance ministers demanded the continuation of the scheme in the pre-budget consultations for 2023–24. 
• The Union Government not only accepted their demand but also surprised them by proposing a huge allocation of Rs 1.3 lakh crore under the scheme for the financial year 2023–24. 
• The guidelines of the scheme not only aim at pushing capital expenditure in the States but also endeavour to facilitate citizen centric reforms and achieve certain national priorities.
• These include urban planning reforms, financing reforms in Urban Local Bodies, incentives for scrapping of old vehicles, construction of a “Unity Mall” in each state, augmenting the housing stock for police personnel, and setting up physical libraries in each gram panchayat and municipal ward.

Strong federal fiscal shield during the pandemic: 

• During the COVID-19 pandemic, the Union Government followed cooperative fiscal federalism to provide resources to states to fight the contagion, boost economic activity, and maintain public services. 
• The Scheme for Financial Assistance to States for Capital Investment was introduced, along with other measures to provide sufficient resources to states. 
• The borrowing limit for states was increased by 2% of the gross state domestic product (GDP) in 2020–21, making financial resources of up to Rs 4.27 lakh crores available. 
• A special window for borrowing was set up in 2020–21, which allowed states to borrow an amount of Rs 1.10 lakh crore as a back-to-back loan to meet the shortfall in GST compensation. 

Conclusion

The Union Government of India is committed to advancing cooperative fiscal federalism in India, as seen by the announcements made in the Union Budget 2023-24 and a variety of initiatives implemented in previous years.

In the coming years, India is likely to move faster along this path. With more freedom and space in their budgets, states will be able to grow more quickly and in more ways, turning India into the “Amrit-Kaal.”