“In this context, what is the current situation with respect to the fiscal health of states and financial devolution? First, it is true that the severe fiscal crisis of the states, which was so marked in the early years of this decade, is no longer as pervasive. Since 2004 all the major deficit indicators have been declining and the revenue and primary deficits are now close to zero for the states as a whole.”____________________
by Jayati Ghosh
(April 23, Chennai, Sri Lanka Guardian) It is often said that "India lives in its states." This is obviously true, but it is also increasingly becoming a means of passing on governmental responsibility from Central to state levels. Under the Constitution, state governments have always had very significant responsibilities (law and order, infrastructure development, health, education and agriculture to name just a few). However, they have not had commensurate powers either to raise resources or to influence broader trends that create the context or enabling conditions for fulfiling these responsibilities.
The assigning of responsibility to states, particularly for economic outcomes is now becoming even more pronounced in the Central government. Thus, in the past week Cabinet ministers in the Central government have argued that the recent rise in the rate of inflation is the problem of state governments and must be dealt with by them. Yet inflation is so clearly a macroeconomic process that it is obviously determined by aggregate national forces and policies. These include not only fiscal and monetary policies, which are the sole preserve of the Centre, but also trade policies and other features that state governments cannot determine but must only respond to.
A wide range of other actions — for example, enactment and enforcement of a Right to Education Bill — are being held up or undermined on spurious concerns about federalism. At the same time, it is common to hear Central government spokespersons argue that "the states are now flush with funds" because of the increase in sales taxes and therefore, do not require further transfer of financial resources from the Centre. The basic difference between the Centre and states — that state governments necessarily face a hard budget constraint unlike the Centre — is forgotten in this context. Also, since the state governments cannot impose service taxes, and therefore, must exclude the fastest growing segment of the economy from their resource raising efforts, means that they are at a significant disadvantage compared to the Centre in this regard.
The basic means of financial transfer is through the successive finance commissions that are supposed to ensure a fair and equitable devolution of fiscal resources from the Centre to states. However, the terms of reference of recent finance commissions have gone beyond the simple allocation of tax revenues between Centre and different states according to a given formula, to allowing and even proposing conditional transfers, even if this goes against the basic principle of federal devolution. Thus, the Eleventh Finance Commission proposed a system of debt relief to states which required them to first pass fiscal responsibility legislation according to parameters laid down by the Centre.
For all the talk of decentralisation, this actually amounts to a greater centralisation of government finances. Direct central allocations to states are increasingly covered by conditionalities, even if they are egregious or unsuitable to the state in question. A case in point is the transfer of funds under the Jawaharlal Nehru National Urban Renewal Mission, which requires problematic measures such as the elimination of stamp duty by recipient state governments. Or they are so rigid that it becomes difficult to adjust the funding to local requirements, as in the case of the Sarva Shiksha Abhiyan where exactly the same norms for expenditure are laid down for all states regardless of differing contexts.
Another attempt to undermine federalism and the authority of elected state governments comes in the arguments for fiscal provisions by the Centre directly to panchayats at district level. With norms for expenditure determined by the Centre, as well as "capacity building" of panchayat members, this amounts to an extremely centralised notion of decentralisation, where the real decisions are made at the very top of national government rather than being delegated to states and then to panchayats.
In this context, what is the current situation with respect to the fiscal health of states and financial devolution? First, it is true that the severe fiscal crisis of the states, which was so marked in the early years of this decade, is no longer as pervasive. Since 2004 all the major deficit indicators have been declining and the revenue and primary deficits are now close to zero for the states as a whole. Even the fiscal deficit total is under three per cent of GDP.
It is generally supposed that this improved fiscal health is the result of the Eleventh Finance Commission’s award, which is perceived to have substantially increased grants to states and also allowed some debt write-off to those states that agreed to pass the controversial fiscal responsibility legislation. However, such a conclusion is not justified. In fact, the significant increase has been in tax receipts of the state governments themselves, which in 2006-07 accounted for more than 55 per cent of their total fiscal resources.
The share of Central taxes has remained small and shown hardly any increase as a proportion of total receipts. In fact, the states’ share of Central taxes as a proportion of the total central tax collection has been declining since 2001-02. All the state governments taken together currently receive just around one quarter of Central tax revenues, even though they are directly responsible for most of the public service delivery that directly affects the lives of people.
What of the total financial devolution, that is including grants and all other mechanisms? In current nominal terms that has certainly been rising. However, as share of GDP of states they have been mostly stagnant in the recent period and indicate some evidence of medium-term decline compared to the early 1990s. This is also true of grants, which have increased only marginally in share of total revenues of the states.
It is sometimes believed that grant funds, which are non-interest bearing and supposedly untied, allow a greater degree of comfort and flexibility to states, and indeed the Eleventh Finance Commission put more emphasis on grants for those reasons, as well as because of the perceived decline in aggregate tax-GDP ratios. However, a substantial — and increasing — proportion of the grants provided to the states come in the form of centrally sponsored schemes (more than 21 per cent) and central schemes (nearly five per cent).
Strictly speaking, transfers for central schemes should not be included in such grants at all or counted as part of devolved resources, since they reflect Central government expenditure that is simply administered by states. Centrally sponsored schemes are also problematic since they typically require matching expenditure by states (of varying proportions according to the scheme) and are in any case completely determined by the Centre, in terms of content, structure, format and process.
So they cannot really be described as devolved funds. This is especially the case given the significant increase in different forms of conditionality that now accompany most, if not all, centrally sponsored schemes.
However, more than one-fourth of all grants to states come in these centralised forms.All this suggests that fiscal federalism still remains somewhat of an empty promise in India, despite all the protestations to the contrary. If this is indeed the case, and the Central government continues to control the bulk of public finances in India, then surely it should also take more responsibility for the economic and social outcomes that are determined by public spending.
- Sri Lanka Guardian
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