Challenges and Issues in Indian Fiscal Federalism

188 Pages·2018·3.154 MB·English

by  Naseer Ahmed Khan (eds.)

India Studies in Business and Economics
Naseer Ahmed Khan
Editor
Challenges and
Issues in Indian
Fiscal Federalism
Forewords by C. Rangarajan
and M. Govinda Rao
India Studies in Business and Economics
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More information about this series at http://www.springer.com/series/11234
Naseer Ahmed Khan
Editor
Challenges and Issues
in Indian Fiscal Federalism
123
Editor
Naseer AhmedKhan
Schoolof Economics
University of Hyderabad
Hyderabad, Telangana
India
ISSN 2198-0012 ISSN 2198-0020 (electronic)
India Studies inBusiness andEconomics
ISBN978-981-10-6216-2 ISBN978-981-10-6217-9 (eBook)
https://doi.org/10.1007/978-981-10-6217-9
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Foreword I
I am happy to write the foreword to this book, which is a collection of selected
papers presented at the national seminar on “Challenges and Issues in the Fiscal
Federalism of India” organized by the School of Economics, University of
Hyderabad towards the end of March 2016. The papers included in this volume
cover varied aspects of federalism. Besides addressing the core issue of fiscal
imbalances and ways to correct them, the articles touch on several issues con-
frontingtheIndianfiscalsystematthecentre,stateandlocallevels.Thearticlesare
well researched and well argued. This book is a valuable addition to the literature
on Fiscal Federalism.
Fiscal federalism is the economic counterpart to political federalism. Fiscal
federalism is concerned with the assignment, on the one hand of functions to
differentlevelsofgovernment,andontheotherwithappropriatefiscalinstruments
for carrying out these functions. It is generally believed that the Central
Government must provide national public goods that render services to the entire
population of the country. A typical example cited is Defence. Local governments
are expected to provide goods and services whose consumption is limited to their
ownjurisdictions.Theargumenthereisthatoutputofsuchgoodsandservicescan
be tailored to meet the preferences and circumstances of the people in that juris-
diction. Such a process of decentralization enhances the economic welfare above
thatwhichcouldresultfromthemoreuniformlevelsofsuchservicesthatarelikely
under a centralized regime. Apart from the provision of national public goods, the
Central Government is to be vested with the responsibilities for economic stabi-
lizationandforincomeredistribution.Whileincomeredistributiontosomeextentis
possible even within sub-national government jurisdictions, a truly redistribution
effort is possible only at the national level. An equally important question in fiscal
federalism is the determination of the specific fiscal instruments that would enable
the different levels of government to carry out their functions. This is the
‘tax-assignment problem’ which is discussed very much in the literature. In
determining the taxes that are best suited for use at different levels of government,
onebasicassumptionthatismadeisinrelationtothemobilityofeconomicagents,
goodsandresources.Veryoftenitisassumedthatwhilethereisnomobilityacross
v
vi ForewordI
national barriers, there is much greater mobility at decentralized levels. This
proposition holds good only partly in an era of globalization. Once again, it is
generally argued that the decentralized levels of government should avoid
non-benefittaxesonmobileunits.ThishastheimplicationthatCentralGovernment
shouldhavetheresponsibilitytolevynon-benefittaxesandtaxesonmobileunitsor
resources.Buildingtheseprinciplesintoanactualschemeofassignmentoftaxesto
different levels of government in a Constitution is indeed very difficult. Different
Constitutions interpret differently what is mobile and what is purely a benefit tax.
For example, in the United States and Canada, both federal and state governments
haveconcurrentpowerstolevyincometax.Onthecontrary,inIndia,incometaxis
levied only by the Central Government though shared with the States. It is inter-
estingtonotethattherevenuescollectedbytheFederalorCentralgovernmentvary
very sharply among different countries. For example, the federal government col-
lects69%ofthetotalrevenueinAustralia,65%inIndiaand48%inCanada.Thus,
the traditional issues in fiscal federalism have been, how to determine the assign-
ment of taxes and responsibilities to different levels of government. Recognizing,
thepossibilityofimbalancebetweenresourcesandresponsibilities,manycountries
have a system of internal governmental transfers. In fact, intergovernmental
transfers constitute a distinctive economic policy instrument in fiscal federalism.
For example, intergovernmental transfers as a percentage of provincial or state
revenues have been 41% in Australia, 40% in India and 20% in Canada in recent
years.Correctingverticalandhorizontalimbalanceshasbeenamajorconcernwith
which fiscal federalism has wrestled with. While actual designs and fiscal transfer
systems differ across federations, these constitute experiments in search of satis-
fying the twin objectives of equity and efficiency in a multi-tiered system of gov-
ernment.Conceptually,theemphasishasbeenonprovidingenoughresourcesatthe
sub-national level to ensure provision of a set of services at comparable or mini-
mum acceptable levels in all jurisdictions.
TheIndianConstitutionlaysdownthefunctionsaswellastaxingpowersofthe
Centre and States. It is against this background that the issues relating to the
correction of vertical and horizontal imbalances have been addressed by every
Finance Commission, taking into account the prevailing set of circumstances.
CentraltransferstoStatesarenot,however,confinedtotherecommendationsofthe
FinanceCommissions.ThereareotherchannelssuchasthosethroughthePlanning
Commission as well the discretionary grants of the Central Government.
TheFourteenthFinanceCommissionhasbrokennewpathintermsofallocation
of resources. One of the major recommendations of the Commission has been to
increase the share of tax devolution to 42% of the divisible pool. This is a sub-
stantial increase by almost 10%. The Fourteenth Finance Commission has argued
thatthisdoesnotnecessarilyaffecttheoveralltransfersbutonlyenhancestheshare
of unconditional transfers. The Chairman writes “The balance in fiscal space thus
remains broadly the same in quantitative terms but tilts in favour of states in
qualitative terms through compositional shift in favour of devolution and hence
fiscalautonomy”.Itistruethatcentrallysponsoredschemeswhichhaveballooned
inrecentyearsandmayhave“encroached”ontheterritoryofstates.Butoveryears,
ForewordI vii
the performance of central government is judged not only on the basis of actions
taken which fall strictly in its jurisdiction but also on initiatives undertaken in the
areas which fall in concurrent and even state lists. Centralized planning has
something to do with it. “Image building” has also contributed to it. One of the
reasonsattributedforincreasingtheshareoftaxdevolutionisthattheshareofcess
and surcharges (which are not shared with states) as a proportion of gross tax
revenue hasincreasedfrom7.53in2000–2001to13.14%in2013–2014.Withthe
increased tax devolution to states, we should not be surprised if this ratio goes
further.ItislegitimatetoargueastheFourteenthFinanceCommissionhasdonein
favourofincreasingtheshareofunconditionaltransfers.Howeversoonerorlater,a
point will be reached when such a transfer can only be at the cost offiscal space
available to the centre to discharge its obligations including correction of
inequalities.Anyfurtherincreasemustbecarefullycalibrated.Atsomestage,even
theConstitutionmayhavetobeamendedtofreezetheproportion.Otherwise,even
the centre will lose the ‘incentive’ or ‘will’ to tax.
In deciding on the horizontal distribution among states, equity considerations
have dominated. While this is legitimate, two factors need to be borne in mind.
First,inthepresentschemeoftaxassignment,someofthetaxeshavebeenlistedin
the centre purely from the angle of administrative convenience and prevention of
leakage. Some part of tax revenue legitimately belongs to states. In the days when
incometaxwastheprimarytaxsharedwithstates,“collection”wasalsoacriterion
indeterminingthesharethatgoestothestates.Stateswhichcontributemoretothe
central pool should not be ignored. Second the above-mentioned consideration
applies even more strongly “when the tax devolution share touches such a high
level as 42%”. Therefore some consideration must be given to assigning some
weight to “contribution” even though one must accept that there are problems in
conceptualizing a variable to measure it.
Irecommendthisbookstronglytostudents,administratorsandpolicymakers—
all of whom will find the book instructive and interesting.
Dr. C. Rangarajan
Chairman, Madras School of Economics, Chennai, India;
Chancellor, University of Hyderabad, India;
Ex-Governor, Reserve Bank of India
Foreword II
Inthisvolume,Dr.Khanhasputtogetheraninterestingsetofresearchpapers.The
volumeisanoutcomeoftheconferenceorganizedbyUniversityofHyderabadand
includes a set of very relevant papers on varied topics in Indian fiscal federalism.
The papers are mostly empirical, dealing with the measurement of differences in
fiscalcapacityamongthestates,impactofintergovernmentalfiscalarrangementson
growth and social outcomes, as well as some specific sectors in Indian economy.
There are papers covering the issues of governance and the effectiveness offiscal
rules as well.
The changing economic and political landscape has put Indian federalism in a
predicament requiring significant policy and institutional changes. The end of
single-partyruleandemergenceofcoalitiongovernmentsatUnionandStatelevels,
the rise of regional parties as pivotal members of ruling coalitions, declining time
horizons in the political landscape has altered the fabric of Indian federalism in
fundamental ways. There is lack of trust between the Union and States when the
rulingpartiesinthelatterarenotapartofthecentralcoalition.Moreimportantly,in
theprevailingenvironment,thereisadireneedforinstitutionsofintergovernmental
coordination, bargaining and conflict resolution. The abolition of the Planning
Commission, while desirable in many ways, has also added to the institutional
vacuuminintergovernmentalcoordination.NITIAyogcanandshouldstepintothis
arena, but it is still in its nascent stage. In the prevailing environment, ensuring
objectivity and transparency promoting intergovernmental relationships is extre-
mely important for ensuring stability and enabling environment for the develop-
ment of India as a nation.
Themarket-basedreformshasunleashedtheforcesofcompetitioninthemarket.
Concomitantly, the role of the State has changed from one of participant in the
production—distributionsystem tothatofan enablerand aregulator toensure fair
competition in the market. In a globalizing environment, provision of competitive
levelsofsocialandphysicalinfrastructurehasbecomeextremelyimportant.Given
the predominant role of the subnational governments in India in the provision of
social services and co-equal role with the Centre in the provision of physical
infrastructure,thefocushasshiftedtopromotingcompetitivefederalism.However,
ix
x ForewordII
it is important to prevent predatory competition and the preconditions for efficient
intergovernmental competition are that there should be a measure of competitive
equality among the jurisdictions and cost–benefit appropriability. In this context,
the issues of governance, taxable capacity differences, ensuring intergovernmental
transferstooffsetrevenueandcostdisabilitiesandeffectoftransfersongrowthand
socialdevelopmentandtheimportanceandeffectivenessoffiscalrules—allbecome
extremely important. While the papers included in the volume may not provide
definitive answers to most of the question, they initiate useful research in these
manifold aspects offederalism. The issues flagged in these papers should be taken
forward and taken up for further research.
Dr. M. Govinda Rao
Emeritus Professor, NIPFP, New Delhi;
ChiefEconomicAdviser,BrickworkRatings;
Member,FourteenthFinanceCommission(2013–14),
GoI