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Redesigning the Fiscal Transfer System in India
An overwhelming proportion of the poor live in low-income states in India. These states are home to over two-thirds of the children in the 0–14 age group. Therefore, provision of comparable levels of basic social services and physical infrastructure is important to ensure balance and stability in the Indian federation. This underlines the importance of intergovernmental transfers. Conceptually, general purpose transfers are given to enable the states to provide comparable levels of public services at comparable tax effort, and specific purpose transfers are given to ensure a minimum standard of public services. The shortcomings in both the design and implementation of the transfer system in India hinder its ability to achieve the objectives.
The author is former director, National Institute of Public Finance and Policy and Member, Fourteenth Finance Commission. The author is grateful to Richard Bird and Y V Reddy for detailed comments on an earlier draft of the paper. It is partly based on the author’s study conducted for NITI Aayog. He also wishes to thank Arvind Panagariya for useful discussions.
An important implementable rule of fiscal decentralisation is that the public services should be, by and large, paid for by the beneficiaries (Bird 2000; Rodden et al 2003). A strong linkage between revenue raising and expenditure decisions or the “Wicksellian Link” is important for reasons of both efficiency and accountability. However, the assignment of revenues and expenditures according to comparative advantage results in vertical imbalances, and wide differences in the fiscal capacity among the states result in horizontal imbalances. Thus, even as it softens the hard budget constraint, fiscal transfers are inevitable. However, it is important to design them to ensure equity along with incentive compatibility.
This paper analyses the design and implementation aspects of general and specific purpose transfers in India. The recommendation of the Fourteenth Finance Commission (FFC) and even more importantly, the abolition of the Planning Commission has brought about a measure of conceptual clarity in the landscape of intergovernmental transfers. The FFC, while covering the entire revenue account requirements of the states in its assessment, has desisted from giving specific purpose grants. Besides analysing the Finance Commission transfers, the paper also brings out important issues relating to some centrally sponsored schemes (CSSs).
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