22 June 2021: UPSC Exam Comprehensive News Analysis

E. Editorials

Category: POLITY AND GOVERNANCE

1. Towards a more federal structure

Background:

• Given the challenges to the unity of India at the time of independence, it was natural that India opted to be a Union unlike the U.S. and many other large countries which have federal governments.
  • Article 1 in the Constitution states that India, that is Bharat, shall be a Union of States.
• Unlike a federal system that divides power between national and local forms of government, the Indian model often referred to as quasi-federal has the Central government wielding more authority and power. Hence the constitutional system of India though basically federal has some striking unitary features. One such aspect is observed in the realm of fiscal federalism.
  • Fiscal federalism deals with the financial relations between units of governments in a federal government system. Fiscal federalism deals with the division of governmental functions and financial relations among levels of government.

Fiscal federalism in India:

• Unlike in federal systems of the U.S. and Switzerland, where both the federal and state governments collect direct taxes, in India, direct tax collection is the exclusive realm of the Central government. States normally derive their income from indirect taxes, most commonly from sales tax. Besides this, State List revenue sources include land revenue, excise on alcoholic liquor, estate duty, tax on vehicles, etc.
• State governments get funds from the Central government according to the Finance Commission’s recommendations.
  • As per the latest Finance Commission recommendations, the Central government is supposed to distribute 41% of its gross tax revenues to the State governments.
  • The horizontal revenue distribution is based on parameters like population and poverty levels.
• A “fragmented” transfer system is a prime feature of the Indian fiscal federal arrangements between the union and the states.  The transfer of financial resources from the union to the states flow through various streams which fall in either of the following categories:
  • General purpose transfers (i.e. states can spend these resources on their respective priorities which can be drawn up by them; or
  • Conditional transfers (i.e. the centre only transfers resources upon the condition that the states must use it for particular programs and schemes drawn up by the centre)
• A substantial proportion of the funds received by the states continue to be conditional transfers which are largely linked to the Centrally Sponsored Schemes.
• The cess levied by the Central government on various items which adds up to over ₹5 lakh crore is not shared with the State governments.
• In recent years, the fiscal relations between the union and state governments have undergone significant changes. Most significant is the introduction of the Goods and Services Tax which have further decreased the revenue collections for the states.

Concerns associated with lack of robust fiscal federalism:

Vertical Imbalances:

• The fiscal asymmetry in powers of taxation vested with the different levels of government in relation to their expenditure responsibilities prescribed by the Indian Constitution has led to vertical imbalances.
  • The central government is given a much greater domain of taxation, as against their expenditure responsibility.
  • At an all-India level, the States get 26% of their total revenue from the Central government.
• The vertical imbalances can have an adverse impact on India’s growth and development.

Horizontal Imbalances:

• The horizontal devolution from the finance commissions, post-1990s, has essentially become a vehicle for coercing states to implement fiscal reforms as part of economic liberalization.
• This move has reduced the policy outreach of the government as they now solely rely on the finance commission, which in turn, leads to a serious problem of increasing regional and sub-regional inequities.
  • Some of the so-called poorer States get up to 50% of their total revenue from the Central government, making them even more dependent.
• It has caused an unfortunate surge in horizontal imbalances because of the differing levels of attainment by the states, resulting from the differential growth rates and their developmental status in terms of the state of social or infrastructure capital.
• This may potentially reduce the states’ capacity to intervene in economic and social sectors.

Politicizing of the fiscal devolution:

• Though the financial devolution to states is based on criteria set by the Finance Commission, often politics intervenes and some States get less and some more. Also, usually, the Central government does not meet the set target for vertical devolution.
• The economic power available to the Central government under this system allows the ruling parties at the Centre to use these funds to their advantage.
• This leads to various States either petitioning or coming into conflict with the Central government on this issue.

Issue of regional disparity:

• Maharashtra, Delhi and Karnataka, Tamil Nadu and Gujarat contribute 72% of the total tax revenue; however, they receive a lesser share of the revenue distributed by the Central government.
• This disparity is more evident when one compares the northern and southern states. States like Uttar Pradesh and Bihar continue to receive a substantial proportion of the revenue distributed despite lower levels of revenue contribution.
• Given the fact that the population growth rates in the south have come down to near zero, whereas the population in central and north India still continues to grow, the cross-subsidy from the south to the north will therefore only grow in the times to come.
• The concerns associated with the disparity of financial devolution along with concerns of the shifting of political power to the more populous northern states post a possible 2026 delimitation exercise have raised apprehensions of political marginalization in the southern states. This could fuel divisive politics in such states.

Recommendations:

• Given the many concerns associated with the current framework of fiscal federalism and the political challenges in addressing them, there is a serious need for redefining India’s current fiscal federalism structure.
• In this direction, there is the need to provide greater economic power to the States so that they can directly collect more taxes and be less dependent on the Central government. The poorer States will need some support from the centre for a transition period.
• Fiscal empowerment of the states rather than the current top-down approach would bring the following benefits:
  • This would improve Centre-State relations given the reduced vertical imbalances.
  • This would not only help the states collect higher revenues, but could accrue critical improvements in terms of efficiency, accountability, manageability and autonomy. Allocation of resources can be done more effectively by states and local governments.
  • Such a step would fiscally empower the states to undertake crucial developmental interventions.
  • Other benefits of fiscal decentralization include: regional and local differences can be taken into account; lower planning and administrative costs; competition among local governments favours organizational and political innovations; and more efficient politics as citizens have more influence.

Conclusion:

• Fiscal federalism is an important aspect of political federalism which needs to be recognized and nurtured to ensure the unity and integrity of the nation.