Federal Fiscal Relations

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Considerations of making the recommendations of the Twelfth Finance Commission more effective require the new commission to (1) remove the artificial restrictions imposed on the finance commissions' scope of operations; (2) keep in view overall macroeconomic stability; (3) streamline management of government debt; (4) provide for appropriate incentives for inducing fiscal responsibility; (5) take a broader and integrated view of tax assignments; and (6) provide operational guidelines for the state level finance commissions.

Sharp deterioration in state finances during the last decade - as evidenced by sharp increases in revenue, fiscal and primary deficits, increases in their indebtedness and contingent liabilities, and decline in capital and maintenance expenditures - has been a matter of serious concern to policy-makers. Low buoyancy of central transfers and spillover of central pay revisions have had the most adverse impact on state finances. However, the states' own fiscal performance has also seen sharp deterioration. On the transfer system, the scheme proposed by the ministry of finance attempts to link a portion of transfers to fiscal reforms. There are serious design issues in the scheme. It is not certain whether the scheme will be effective either. The paper details the areas of reform the states should focus on to impart efficiency and improve revenue productivity and prioritisation and compression of unproductive expenditures.