Essays: New Economic Measures on Fiscal Ties Between the Union & States in India (August 2024) | Current Affairs & Hindu Analysis: Daily, Weekly & Monthly - UPSC PDF Download

Monetary Policy is Like Juggling Six Balls, It is not Interest Rate Up, Interest Rate Down. There is the Exchange Rate, There are Long Term Yields, There are Short Term Yields, There is Credit Growth. — Raghuram Rajan

The fiscal dynamics between the Union and the states in India is a sophisticated and evolving structure shaped by its federal system. This relationship has seen considerable changes since India’s independence in 1947, influenced by constitutional mandates, economic policies, and political factors. Recent economic reforms, especially in the past decade, have notably affected this relationship.

Under British colonial rule, fiscal relations were marked by centralized control and limited financial autonomy for provinces. The Government of India Act, 1935 was a pivotal reform that introduced provincial autonomy and revenue sharing between the central and provincial governments.

Post-independence, the Indian Constitution established a federal framework with a strong unitary bias. It defined the fiscal roles and duties of the Union and state governments through the Union List, State List, and Concurrent List. The Seventh Schedule allocated exclusive powers to both the Union and state governments, while the Concurrent List allowed for shared responsibilities. The Finance Commission was also created to oversee the distribution of tax revenues.

The Goods and Services Tax (GST), introduced in 2017, was a significant reform aimed at creating a unified national market by replacing numerous central and state taxes with a single tax. GST replaced various indirect taxes, including excise duty, service tax, and state-level VAT.

The implementation of GST has notably transformed the fiscal landscape in India. It has reduced state fiscal autonomy by subsuming several state taxes but introduced a collaborative decision-making process through the GST Council, which includes representation from both the Union and the states. This has promoted cooperative federalism but also led to disputes over revenue sharing and compensation.

The GST compensation mechanism was designed to compensate states for revenue shortfalls due to GST implementation for the first five years. Delays in compensation payments have strained state finances and underscored their reliance on central transfers.

The Fourteenth Finance Commission (2015-2020) recommended increasing the share of states in the central tax pool from 32% to 42%, aiming to enhance state fiscal autonomy and empower states for development activities.

While this increased devolution has given states more financial resources, it has also shifted the responsibility for fiscal management to the states. Some states have effectively utilized the additional resources for development, while others have faced challenges with fiscal discipline.

Centrally Sponsored Schemes (CSS) are central government-funded programs implemented by states. The government’s effort to rationalize these schemes aimed to reduce their number and increase state flexibility in fund utilization. This move addressed the issue of rigid schemes that did not cater to regional variations.

Despite increased flexibility, states remain dependent on central funding for CSS, which limits their financial autonomy. The conditions attached to this funding often restrict states' ability to innovate and prioritize local needs.

The Fiscal Responsibility and Budget Management (FRBM) Act, 2003 sought to institutionalize fiscal discipline and reduce fiscal deficits. Amendments to the FRBM Act have introduced more flexible fiscal targets, granting states greater leeway in managing their fiscal deficits during economic stress.

These amendments provide a framework for prudent fiscal management, allowing states to take counter-cyclical measures during downturns. However, the success of these measures depends on states' commitment to fiscal discipline and effective governance.

The transition to GST and dependence on central transfers have introduced revenue uncertainties for states. Delays in GST compensation payments have worsened fiscal stress, particularly for states with weaker revenue bases.

Increased tax devolution has not fully addressed fiscal imbalances among states. States with stronger economies continue to have better revenue capacities, while poorer states remain reliant on central transfers.

Despite efforts to enhance state autonomy, central government control over financial transfers through CSS and other grants still limits full financial independence for states.

The GST Council and other collaborative forums offer a chance to strengthen cooperative federalism in India. By encouraging dialogue and consensus-building, these platforms can tackle fiscal federalism issues and promote a more balanced fiscal relationship between the Union and states.

Increased devolution of taxes and amendments to the FRBM Act provide states with greater financial resources and flexibility, presenting opportunities for improved fiscal prudence, expenditure management, and sustainable development.

The rationalization of CSS and greater fund utilization flexibility enable states to design and implement programs that meet regional needs, potentially fostering balanced regional development and reducing disparities.

Recent economic measures have significantly impacted the fiscal relationship between the Union and states. While they have granted more resources and flexibility to states, they have also introduced challenges like revenue uncertainty and central control. The success of these measures in improving fiscal federalism will depend on the commitment of both the Union and state governments to cooperative federalism, fiscal discipline, and equitable development.

Federalism is no Longer the Fault Line of Centre-State Relations but The Definition of a New Partnership of Team India. Citizens now have the Ease of Trust, not the Burden of Proof and Process. — Narendra Modi