Fiscal Centralization

REFERENCE NEWS:

• Since the Fourteenth Finance Commission in 2015-16 recommended increasing Union tax revenue devolution to States to 42%, the Union government has paradoxically cut financial transfers to States, a trend towards fiscal centralisation that persisted even after the Fifteenth Finance Commission endorsed a similar rate of 41%, accounting for the reclassification of Jammu and Kashmir (J&K) and Ladakh. Despite these recommendations, the Union has reduced state transfers while increasing its revenue for discretionary spending.
• The recent political uproar, following the presentation of the Interim Union Budget of 2024-25, highlights the tensions over fiscal centralisation, with allegations that the Central government's approach contradicts the spirit of Fiscal Federalism.
  • Statutory grants-in-aid to states have seen a reduction, with direct financial support decreasing from ?1.95 lakh crore in 2015-16 to ?1.65 lakh crore in 2023-24, thereby limiting the financial resources available to states.

ARGUMENTS HIGHLIGHTING FISCAL CENTRALIZATION IN THE COUNTRY:

• Changes in Tax Revenue Sharing:
  • The share of States in the gross tax revenue decreased from 35% in 2015-16 to 30% in 2023-24 (Budget Estimate), despite an increase in the gross tax revenue of the Union government.
  • The increasing collection of cess and surcharge, which do not need to be shared with States, has contributed to this decline.
• Increase in Non-devolvable Cess and Surcharge: 
  • The Union government has increased its collection of cess and surcharges, which do not need to be shared with states, from 5.9% of its tax revenue in 2015-16 to 10.8% in 2023-24, thus increasing its own discretionary spending power.
• Decline in Grants-in-Aid
• Centralisation of Public Expenditure
  • The Union government has increased allocations for Centrally Sponsored Schemes (CSS) and Central Sector Schemes (CSec Schemes), leading to more centralized control over public expenditure.
  • This centralisation limits the states' autonomy in financial planning and expenditure.
• Impact of GST on State Fiscal Autonomy:
  • The implementation of the Goods and Services Tax (GST) has significantly reduced the states' ability to independently determine tax rates, affecting their fiscal autonomy.
• Issues with GST Implementation: 
  • The discontinuation of GST compensation cess and other challenges have not fully addressed the revenue loss to states due to GST implementation, impacting their financial stability.

CHALLENGES AND DRAWBACKS OF FISCAL CENTRALIZATION IN INDIA:

• Impact on State Revenues and Expenditure Patterns: 
  • States have lost revenue-generating capacity following the GST regime's introduction and are compelled to allocate significant portions of their budgets to centrally sponsored schemes. This scenario has led to a decline in the states' ability to finance their expenditures from their own revenues, from 69% in 1955-56 to less than 38% in 2019-20.
• Amplify fiscal disparities and contradicts cooperative federalism:
  • The impact of CSS and CSec Schemes, alongside reduced financial devolution and increased centralization, starkly affects state equity and autonomy.
  • Wealthier states better navigate fiscal challenges, utilizing Union funds efficiently, while poorer states may deepen their debt for CSS participation, amplifying fiscal disparities. This trend contradicts the goals of cooperative federalism, aimed at balanced and equitable state development.
• Curb the autonomy of states:
  • By turning States into mere implementing agencies of the Union’s schemes, their autonomy has been curbed.
  • The diversion of a state’s own funds to centrally sponsored schemes results in depleting resources for its (state’s) own schemes.
• Decreased Role of State in Development Initiatives: 
  • The prioritization of centrally sponsored schemes, often based on a one-size-fits-all approach, undermines states' ability to develop and implement schemes that address their unique socio-economic challenges.
• Impingement on Fiscal Federalism Principles:
  • Increased centralization contradicts the principles of fiscal federalism, which advocate for a balance of financial powers between the central and state governments.
  • Also a centrally sponsored scheme on an item that is in the State list and State sharing the expenditure of a scheme on the Union list(Central Sector Scheme) is against the spirit of federalism, specifically fiscal federalism.
• Potential Bias in Resource Allocation:
  • The allocation of funds from Central Sector Schemes, fully funded by the central government, has raised concerns over potential biases in resource distribution. There are apprehensions that the central government may favor certain states over others, leading to uneven development and fostering regional disparities.

WAY FORWARD:

• Revisiting Tax Sharing Mechanisms: The Union government could consider increasing the share of states in the gross tax revenue to reflect the recommendations of the Finance Commissions more accurately. 
• Rationalizing Cess and Surcharge: Limiting the use of cess and surcharge to specific, time-bound projects and ensuring a portion of these collections is shared with states could help mitigate the reduction in states' shares of central revenues.
• Reviewing and Rebalancing CSS and CSec Schemes: A critical evaluation of existing Centrally Sponsored and Central Sector Schemes is necessary to ensure they align with national priorities without compromising state autonomy. Encouraging states' participation in designing and implementing these schemes can ensure they are more tailored to local needs.
• Flexibility in Fund Utilization: States should be given more flexibility in using funds received through CSS and CSec Schemes, allowing them to prioritize according to their development needs.
• Strengthening the Finance Commission: Empowering the Finance Commission to play a more active role in monitoring and ensuring the fair implementation of its recommendations could help address fiscal imbalances.
• Enhanced Coordination Mechanisms: Establishing a more robust institutional framework for Centre-State dialogue, such as through the Inter-State Council, could facilitate better coordination and address grievances related to fiscal policies.
• Transparent Mechanism for Resource Allocation: Developing a transparent and objective mechanism for the allocation of funds under various schemes can help reduce potential biases and ensure equitable development across states.
• Regular Review and Audit: Implementing a regular review and audit process for financial transfers and expenditures under CSS and CSec Schemes can ensure accountability and efficient use of resources.
• Strengthening the GST Council: Enhancing the role of the GST Council to address the concerns of states more effectively and to ensure that revenue loss compensation mechanisms are fair and timely.
• Exploring Alternative Revenue Sources for States: Identifying and enabling alternative revenue-generating mechanisms for states to compensate for the limitations imposed by GST on their fiscal autonomy.
• Encouraging State-specific Initiatives: The Union should encourage and support state-specific initiatives that cater to the unique socio-economic challenges of each state, promoting innovation and experimentation in governance.
• Building Consensus on Fiscal Policies: Engaging in broader consultations with states before introducing major fiscal policies or reforms can help build consensus and ensure policies are in line with the principles of cooperative federalism.

PRACTICE QUESTION:

Q. “The trend towards fiscal centralization in India has several adverse implications”. Discuss. (10 marks, 150 words)