Rethink the dynamics of India's fiscal federalism

Context: The article is discussing the Indian Constitution’s structure as a “holding together federation” with a unitary bias, which was developed in response to the centrifugal forces and tendencies towards fragmentation during the lead-up to India’s Independence. It goes on to discuss how the Indian Constitution has evolved over the past 73 years, highlighting various factors that have affected the country’s fiscal federalism. Overall, the passage appears to be discussing the evolution of India’s fiscal federalism, the factors that have influenced it, and specific challenges and issues that need to be addressed to ensure a balanced and effective fiscal system.

Decoding the Editorial

The article discusses several key changes that have taken place in India’s fiscal landscape:

Transition from Planned Economy to Market-Mediated System: The shift from a planned economy to a market-mediated economic system has implications for how fiscal policies are formulated and executed within the federal structure.
Transformation into a Multi-Tier Fiscal System: The 73rd and 74th Constitutional Amendments expanded the federal structure by creating a multi-tier fiscal system, which likely requires adjustments in terms of intergovernmental transfers and fiscal responsibilities.
Replacement of Planning Commission with NITI Aayog: The abolition of the Planning Commission and the establishment of NITI Aayog marked a change in how economic planning and policy recommendations are made, potentially impacting fiscal arrangements.
Fiscal Responsibility and Budget Management (FRBM) Act: The enactment of the FRBM Act aimed to ensure fiscal discipline and responsibility, affecting both central and state governments.
Goods and Services Tax (GST) Act: The introduction of the GST Act and the establishment of the GST Council as a controlling authority brought significant changes to the tax structure and revenue sharing between the centre and the states.
Use of Cess and Surcharges: The use of cess and surcharges in revenue collection has implications for the size of the divisible pool of funds available for distribution among the central and state governments.

The article also raises issues related to India’s fiscal federalism:

Equity-Oriented Intergovernmental Transfers: The article suggests that India’s intergovernmental transfer system should be more equity-oriented, likely implying a need to ensure that the distribution of funds among different tiers of government is fair and equitable.
Income Inequality: It highlights the concerns about rising income inequality in India over different eras and the impact of tax exemptions and concessions on the distribution of income and revenue.
Fiscal Policy Review: The article indicates a need to review various issues that have arisen due to the changes in India’s fiscal landscape, likely emphasising the importance of reevaluating fiscal policies and arrangements to align with the evolving economic and political context.

Equity as a concern for the 16th Finance Body:

The article goes on to discuss several interconnected issues related to fiscal federalism, governance, and the distribution of powers and responsibilities in India’s evolving political and economic landscape.

Divergence in Per Capita Income (PCI) and Human Development Index (HDI): There has been a trend of increasing divergence in per capita income (PCI) among 16 major states from 1970-71 to 2020-21, based on data from the Economic and Political Weekly Research Foundation (EPWRF).
Equity as the Concern of the 16th Finance Commission: The article suggests that equity should be the primary focus of the 16th Finance Commission. It proposes that the Human Development Index (HDI) could be a strong candidate for consideration in the horizontal distribution of tax devolution among states.
Revisiting Article 246 and Seventh Schedule: There is a need for reexamination of Article 246 and the Seventh Schedule of the Indian Constitution, which outline the distribution of legislative powers between the centre and the states. It is suggested that changes are needed due to shifts in governance, society, technology, and the development paradigm since the time of constitution-making.
Challenges with Changing Dispensation: India’s political landscape has transformed from a one-party system to a multi-party system. This shift, along with changes in technology, society, demographics, and development approaches, requires a reconsideration of how powers and responsibilities are allocated between different levels of government.
Central Legislation and State Burden: The article discusses how certain central legislation, such as the Mahatma Gandhi National Rural Employment Guarantee Act, the Right of Children to Free and Compulsory Education Act, and the National Food Security Act, place additional burdens on the states. This prompts consideration for shifting certain subjects, like education, from the Concurrent List to the State List.
Lack of Clear Division of Responsibilities: The article critiques the lack of clarity in the division of powers and responsibilities between different levels of government in India. It points out that even though the 73rd and 74th Constitutional Amendments provided an opportunity to address this issue, confusion persisted, and more clarity is needed in the functional and financial roles of panchayat raj institutions and municipalities.

A respectable place for Local Self Government Institutions:

The article discusses several issues related to the role and status of the third tier of government-local self-government institutions in India.

Placement of the Third Tier on the Fiscal Federal Map: The third tier of government has not been placed properly within India’s fiscal federal structure. There has been a persistent failure to adequately recognize and accommodate local self-government institutions within the broader fiscal framework.
Lack of Uniform Financial Reporting System: There is an absence of a consistent financial reporting system that encompasses all levels of government, including local bodies. There is a need for standardised budgeting rules and the adoption of an accrual-based accounting system across all tiers of government.
Identity of the Third Tier: While the Constitution refers to the third tier as “institutions of self-government,” there seems to be a discrepancy in how these institutions are referred to by policymakers, experts, and even entities like the Union Finance Commissions (UFCs). Instead of being recognized with their proper designation, they are often simply referred to as “local bodies.” This suggests a lack of respect and proper recognition of their role and significance.
Challenges in Building Local Democratic Base: There has been a perceived failure in building a strong local democratic foundation in India, despite having a vast number of elected representatives at the local level. There are over 3.2 million elected representatives and 2.5 lakh rural and urban local governments. Despite this, there seems to be an unexplained “enigma” surrounding the inability to effectively empower and utilize this local democratic structure.
Importance of Local Governments: The passage emphasizes that local self-government institutions have a critical role to play in a diverse and heterogeneous federation like India. They are seen as essential for providing basic services of consistent quality to all citizens, regardless of their place of residence.

Need for a review of Off Budget Borrowing:

The article is discussing the need for a review of off-budget borrowing practices in India, particularly by both the central government (Union) and the state governments.

Off-Budget Borrowing Defined: Off-budget borrowing refers to the practice of raising funds through borrowing that are not explicitly included in the government’s official budget. Despite not being part of the budget, the repayment obligations for these borrowings are ultimately the responsibility of the government.
Concerns with Off-Budget Borrowing: The article highlights several concerns associated with off-budget borrowing. These borrowings are often not subject to the same level of scrutiny and reporting as on-budget transactions. This lack of transparency can lead to financial imbalances and hidden liabilities.
State Involvement: State-level entities like public sector undertakings and special purpose vehicles also engage in off-budget borrowing. While they raise resources from the market, the responsibility for repaying the debt may fall on the state government, especially in cases where the government guarantees the debt.
Union Government’s Off-Budget Borrowing: The article suggests that the central government might be engaging in off-budget borrowing practices more than state governments. The use of the National Small Saving Fund (NSSF) for financing central public sector undertakings and ministries through loans is highlighted as an example. This practice is not fully reflected in the Union’s fiscal deficits, which raises concerns about accountability.
Imbalances in Borrowing Space: While state governments face certain restrictions on borrowing, the central government often has more flexibility and escapes similar controls. This can create imbalances in fiscal discipline.
Special Banking Arrangements: The article mentions the use of special banking arrangements involving public sector banks. These arrangements facilitate cash and credit flow for activities outside the government’s budget, and the transparency of such operations is questioned.
Transparency and Accountability: The article emphasizes the importance of transparency and public accountability. It calls for all levels of government, including the Union, states, and local governments, to ensure that all extra-budgetary transactions are openly disclosed and reported.
Reevaluation of Fiscal Federalism: It is suggested that the evolving dynamics of India’s fiscal federalism require significant rethinking, especially in the context of the 16th Finance Commission.