ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Central Transfers and Tax Generation Efforts of Indian States

The impact of federal transfers on revenue collection by state governments in India in 1992–2013 is re-examined. Several overlooked aspects in previous studies that tested the asymmetric effect of transfers in India are addressed. When we disaggregate total transfers into conditional and unconditional transfers, we find that while tax collection decreases with an increase in unconditional transfers, conditional transfers seem to exert a positive influence on tax collection. The findings raise serious concerns regarding the pattern of intergovernmental transfers in India.

The authors wish to gratefully acknowledge the thought-provoking and helpful comments of the anonymous referee.

In a federation of states, the fundamental objectives of intergovernmental transfers are to achieve allocative efficiency, equity in distribution, fiscal balance, and competitive equality among governments (Breton 1965; Buchanan 1950; Musgrave 1961). Additionally, intergovernmental transfers may be used to convince state governments to spend on areas considered crucial by the central government (Musgrave 1976). Indian states, like all other federations, must confront the problem of horizontal and vertical imbalances. However, irrespective of the revenue-generating capacity of state governments, it is still their
responsibility to provide citizens with a comparable standard of services. Therefore, in the process of fulfilling their responsibilities, some states may incur expenditures that are disproportionate to their revenue-generating capacity.

In order to bridge this financial gap between the different layers of governments, the Constitution has provided an institutional framework to facilitate transfers from the central government to the states. These transfers often empower subnational governments to exercise their autonomy in making fiscal adjustments while carrying out their own responsibilities. Therefore, depending on their nature, intergovernmental transfers may result in two different kinds of expansionary fiscal policies: tax cuts and increased government spending. Moreover, state governments may respond with different kinds of fiscal measures when faced with a decline in transfers as opposed to an increase in the same (Gramlich 1987). Therefore, the utilisation of financial aid from the highest layer of government in a federation is a very interesting area of empirical research. However, despite India being the largest federation in the world, research on these issues has been very limited. The few studies that exist also suffer from a number of flaws (Chelliah 1981; Lalvani 2002; Rajaraman and Vasishtha 2000; Dash and Raja 2013).

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Updated On : 5th Dec, 2019
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