India’s Fiscal Federalism UPSC NOTE

India’s fiscal federalism and issues

The current context of economic relations between the Centre and States is very different from the 1980s and 1990s.
Continuing economic reforms since 1991 has led to the relaxation of many controls on investments, giving some room to States.
But the autonomy regarding public expenditure policies is not absolute as State governments depend on the Centre for their revenue receipts.
Several States have recently pushed back as a result of which the ‘give and take’ equation between the Centre and the States.

The increasingly fractious Centre-State ties have chipped away at the edifice of cooperative federalism.
Sites of conflict includes the homogenisation of social sector policies, functioning of regulatory institutions and the powers of central agencies.
Ideally bulk of the policies in these spheres should be at the discretion of States, with an apex central body overseeing the process of resource allocation.
However, the apex bodies have often attempted to increase their influence and push States in directions that are amenable to the Centre.

How It impacts states working

There are three important economic consequences of these incursions.
First, the spread of the Centre’s span of activities leads to a situation where the Centre starts crowding out the States in terms of investments.
The Centre launched the PM Gati Shakti, a digital platform, to incorporate schemes of various Ministries and State governments to achieve integrated planning and coordinated implementation of infrastructure connectivity projects.
All States and UTs had to prepare and operationalise a State master plan in line with the national master plan.

The flexibility of States in formulating their master plan is curtailed by the centralisation of planning and implementation of the national master plan.
This leads to underinvestment by States as is evident from the fact that the combined capital expenditure (capex) of the 16 large States, which account for 80% of the country’s gross domestic product, on roads and bridges fell to 0.58% of the gross state domestic product.
At the same time in absolute terms, the centre’s capex on roads increased at a compound annual growth rate of 32.3% since 2015-16.

Spending has become more concentrated within the three largest States of Uttar Pradesh, Maharashtra and Gujarat, accounting for nearly half of the expenditure by 16 States between 2021-22 and 2023-24.
Data for 25 States shows that a total of ₹7.49 lakh crore was budgeted for by these States but they spent only ₹5.71 lakh crore which is 76.2% of the total.
Investment by these States is important in terms of their impact on regional economies as they induce more local level linkages while national infrastructure projects forge more linkages with the global economy.

The second outcome has been a peculiar form of fiscal competition between the Centre and States.
In a federal system, fiscal competition manifests between different regions/States.
Scenario of frictions with the Centre, State governments will engage in competition with other States and with the Centre.
The Centre with enhanced fiscal space has more spending power, while States’ revenues, especially non-tax revenues, remain flat as possibilities of raising non-taxes are confined to a smaller sphere due to the direct provisioning of many utilities and services by the Centre.

Steps to be taken

Centre-state conflict is a common phenomenon in federal systems.
Where power is divided between the central government and the states.
This conflict can arise due to various factors, such as differences in ideology, resource allocation, and territorial disputes.

Steps that can be taken to reduce center-state conflict:

India’s Fiscal Federalism

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