Fiscal Federalism in India

Fiscal Federalism in India

Swaniti Initiative | February 28, 2015 | The Swaniti Blog

Date of Release: February 28th, 2015

Published in: International Policy Digest

The recommendations of the Fourteenth Finance Commission (FFC) have been hailed almost unanimously for ushering in a new era for centre-state relations in India. The most significant of these recommendations – accepted by the central government – is the one that devolves 42% of the divisible share in the centrally levied tax pool to the states, a radical 10 percentage point jump from the previous commission’s recommendations.

The benefits of such an arrangement are quite obvious. The very basis of cooperative federalism lies in ensuring that a strong centre is supported by equally strong federal units (the states), which is possible only if states enjoy far greater financial autonomy than they have in the past. The enlarged share (42%) would allow states much greater flexibility in planning and implementing development programmes, which should enhance the efficiency of public expenditures in the long-run. After all, the “one-size-fits-all” approach has perhaps been the bane of our centrally controlled economic model since independence. Greater devolution can also be expected to foster greater, and hopefully healthier economic competition between states, which would push us faster along the “reform” path we chose for ourselves in 1991.

As important as these changes in centre-state relations are, they often ignore another significant institutional change that happened in the early years of the post-liberalization era. In 1992, through the 73rd and 74th amendments to our constitution, a third tier (Panchayats and urban local bodies) became firmly embedded in India’s federal structure. But while these laws promised much, the experience of political decentralization in the past twenty three years has been a mixed one.

Multiple studies have shown that Panchayats have led to several positive developments in the Indian countryside, prominent among them being greater political awareness, political empowerment of women and other marginalized sections and most importantly, evolution of local solutions to developmental challenges. But, financial empowerment of Panchayats and local bodies is still not commensurate with the functions that these bodies are envisaged to perform. Though this third tier has no legislative powers, it is expected to perform a variety of executive functions related to critical social sectors such as health and sanitation, nutrition, education, drinking water and agriculture. This can be possible only with more financial autonomy.

The 13th Finance Commission (TFC) marked a significant shift from the earlier practice of ad-hoc grants to local bodies. It instead officially recognized them as the third tier, earmarking a certain share for them within the divisible pool of central taxes. However, this can merely supplement rather than supplant two other sources of funds for these bodies. The first are grants provided by the respective states, and the second include greater powers to levy taxes, which can only be done by amending the respective state legislations relating to Panchayats and urban local bodies. Clearly, in both these cases, the onus lies on the states.

A tremendous opportunity has now been presented to the states with the devolution of a much larger share of untied funds to them. While each state would need to chalk out its own roadmap to utilize this larger corpus at their disposal, they would do well to start by addressing the condition of local bodies within their jurisdiction. While Panchayats in states like Kerala, Tamil Nadu and even in some north-eastern states like Sikkim are sufficiently empowered, those in other parts are crying out for attention. It must be realized that while states will now have greater flexibility in the implementation of development schemes, the efficiency of their implementation will depend to a large extent on the strength of local bodies. Poverty alleviation programmes will require Panchayats to play a proactive and constructive role.

According to an earlier analysis by Swaniti Initiative, Maharashtra did very well in the social sector in the past 10 years, which directly correlated with the strength of Panchayats in the state. The state has consistently been at the top of the rankings in the Devolution Index (IIPA), which measures the extent of devolution of finances, functions and functionaries by states to their Panchayats. Similarly, schemes for urban development simply cannot succeed without municipalities. Though the concept of a “smart city” remains nebulous, most will agree that “smart governance” will hold the key to a smart city, for which municipal bodies will need be sufficiently empowered.

One argument against financial empowerment of local bodies is that they contribute to “decentralization of corruption.” The burgeoning number of elected representatives in the past two decades may have led to greater corruption at the grassroots, but it must not be forgotten that these Panchayats also act as fulcrums around which community mobilization is possible. The best checks against corruption are transparency and accountability, which are easiest to institutionalize in the lowest tier. In the absence of effective Panchayats, a centralized form of corruption would be even more difficult to weed out. Local bodies do not just implement programmes, they offer people a voice, which allows them to act as a bulwark against corruption and inefficiency – including those by the local bodies themselves.

Eventually, strengthening of this bottom tier will depend on the attitudes of the states. For one, it is important to look at grassroots leaders as partners in the goal of socio-economic development, rather than being inimical to it. These bodies are often dismissed as symbols of romantic Gandhian ideals of “Swaraj” and “Sarvodaya,” or of the agenda of activists of a particular political persuasion who are perceived as anti-growth.

The truth is that these institutions are more than just that. They hold immense practical value for all stakeholders, including state governments. If innovation and technology are indeed going to be the drivers of growth in the coming years, Panchayats and municipalities will be important partners in this journey. The Modi slogans of “4P” (People-Public-Private-Partnership) and Adarsh Gram (Model Village) thankfully reinforce this point.

The untied corpus of Rs 2.83 lakh crores to be devolved to local bodies by the centre (another recommendation of the FFC accepted by the central government) should only be a trigger for far greater financial devolution by the states themselves. A radical increase from 32 to 42% cannot work if the third tier doesn’t benefit from it.

For the sake of genuinely cooperative and participatory federalism, as well as inclusive and sustainable growth, this tier simply cannot be allowed to wither away. The latest Economic Survey very aptly observes – “(t)he necessary, indeed vital, encompassing of…local bodies within the embrace of cooperative and competitive federalism is the next policy challenge.”