Daily Editorial Analysis for 28th July 2022

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The poor state of India’s fiscal federalism

GS Paper 3: Functions and Responsibilities of the Union and the States, Issues and Challenges Pertaining to the Federal Structure, Devolution of Powers and Finances up to Local Levels and Challenges Therein.
Important For:
Mains exam: Challenges to Fiscal Federalism
The asymmetric federalism
This asymmetric fiscal federalism, inherent to the Constitution, was accelerated and mutually reinforced when GST was introduced, making the Union Government extractive rather than enabling. While States lost their capacity to generate revenue with the introduction of Goods and Services Tax (GST) regime, their expenditure pattern too was distorted.

What the Constitutional makers had opined?

• In his last speech, in 1949, to the Constituent Assembly, B.R. Ambedkar sounded a note of caution about the Indian republic entering a life of contradictions.
• He warned “In politics we will have equality and in social and economic life we will have inequality. These conflicts demanded attention: fail to do so, and those denied will blow up the structure of political democracy”.
• A degree of centralisation in fiscal power was required to address the concerns of socio-economic and regional disparities, he felt.

Increased dependence on Finance Commission

• Historically, India’s fiscal transfer worked through two pillars, i.e., the Planning Commission and the Finance Commission.
• The abolition of planning commission in 2014, led to the Finance Commission becoming a major means of fiscal transfer as the commission itself broadened its scope of sharing all taxes since 2000 from its original design of just two taxes — income tax and Union excise duties.
• The sates have become highly dependent on Finance commission for finances which is appointed by the Central Government and states have no role in this appointment.
Hollowing out fiscal capacity
• The ability of States to finance current expenditures from their own revenues has declined from 69% in 1955-56 to less than 38% in 2019-20.
• Impact of GST: While the expenditure of the States has been shooting up, their revenues did not.
o They still spend 60% of the expenditure in the country — 85% in education and 82% in health. Since States cannot raise tax revenue because of curtailed indirect tax rights — subsumed under GST.
• Shrinking of divisible pool: Even the increased share of devolution, mooted by the Fourteenth Finance Commission, from 32% to 42%, was subverted by raising non-divisive cess and surcharges that go directly into the Union kitty.
o This non-divisive pool in the Centre’s gross tax revenues shot up to 15.7% in 2020 from 9.43% in 2012, shrinking the divisible pool of resources for transfers to States.
• Cut in corporate tax: The recent drastic cut in corporate tax, with its adverse impact on the divisible pool, and ending GST compensation to States have had huge consequences.
• Differential rate of Interest: States are forced to pay differential interest — about 10% against 7% — by the Union for market borrowings.
• Centrally sponsored schemes: By turning States into mere implementing agencies of the Union’s schemes, their autonomy has been curbed.
o There are 131 centrally sponsored schemes, with a few dozen of them accounting for 90% of the allocation, and States required to share a part of the cost.
o These schemes, driven by the one-size-fits-all approach, are given precedence over State schemes, undermining the electorally mandated democratic politics of States.
o The diversion of a State’s own funds to centrally sponsored schemes, thereby depleting resources for its own schemes, violates constitutional provision.

Deepening inequality

• This political centralisation has only deepened inequality.
• The World Inequality Report estimates ‘that the ratio of private wealth to national income increased from 290% in 1980 to 555% in 2020, one of the fastest such increases in the world.
o The poorest half of the population has less than 6% of the wealth while the top 10% nearly grab two-third of it’.


India’s fiscal federalism driven by political centralisation has deepened socio-economic inequality, belying the dreams of the founding fathers who saw a cure for such inequities in planning. It has not altered inter-state disparities either. If there was anything that alleviated poverty, reduced inequality and improved the well-being of people, these were the time-tested schemes of State governments, but they are now under threat.

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