Federalism and Fiscal Transfers in India is a collection of recent articles by C Rangarajan and D K Srivastava on fiscal federalism and sustainable fiscal policy. It includes eight essays and except for the essays on the basic tenet of fiscal federalism and contemporary challenges, these have already been published in the Economic and Political Weekly. Of the eight essays included in the volume, six are on fiscal federalism and intergovernmental finance, and the remaining two are on sustainable fiscal policy dealing with debt and deficits. The papers included in the volume deal with both theory and policy. Fiscal federalism, in particular, is an area where not much analytical literature is available and therefore, the book is an important contribution. It is useful for both students of fiscal federalism as well as policy makers dealing with intergovernmental finance.
The first paper discusses the developments in theories of fiscal federalism. This is followed by a paper on the evolution of Indian fiscal federalism. The next two papers are devoted to the comparison of practices in intergovernmental finance between India and Canada, and India and Australia; the two well functioning federal fiscal systems. The fifth essay is devoted to analysing the issue of resolving vertical and horizontal imbalances in Indian federation. The next two articles deal with fiscal sustainability. While one article is on the debt dynamics, another article examines the implications of large fiscal deficits and increasing debt on economic growth and stabilisation. The final paper brings together contemporary challenges and issues before the 13th Finance Commission.
In the essay on basic tenets, the authors review theoretical literature on fiscal federalism and intergovernmental finance. Obviously, the literature is vast and the treatment ends up providing a bird?s eyeview of both the first and second generation theories. There are interesting insights not only from the traditional fiscal federalism theories of ?exit? and ?voice? based on the assumption of a benevolent state, but also, the more recent developments based on public choice by applying industrial organisation theories, market promoting federalism as well as competitive federalism.
Of course, the review only provides a broad brush. Furthermore, the pre-conditions listed for market promoting federalism are not complete and contrary to the assertion made in the essay, competitive federalism literature shows that it is possible to achieve stable and efficient intergovernmental competition without having to depend on the assumption of an altruistic state. Nevertheless, the review of theoretical development provides a useful starting point.
The paper on the evolution of fiscal federalism in India is more about the evolution of the transfer system by the finance commission rather than about the evolution of Indian fiscal federalism per se. It attempts to show that the incorporation of tax effort index and fiscal discipline by the recent commissions has overcome the problem of perverse incentives, but the arguments are not very convincing. As long as the basic approach of determining the overall entitlements of states on the basis of gaps in projected revenues and expenditures remain, the factors included for determining the various components of transfers is secondary. This is the basic difference between the Australian and the Canadian systems, and the approach adopted by the Indian finance commissions. The finance commissions incorporate capacity equalisation, efficiency promoting incentives and allowance for cost disabilities in revenue sharing formula, which seeks to take into account revenue and cost disabilities in the transfer system, which may not be appropriate. Furthermore, it must also be mentioned that the measures of tax effort and cost disability proxied by the finance commissions have several shortcomings. Taxable capacity of a state depends not only on its per capita income, but also, its composition and a variety of other factors. To simply assume that capacity increases at a pre-judged exponential with per capita income is not at all scientific.
The next two essays describe the systems in Canada and Australia, and compare them with India. Canada has a system of equalisation in which the states with below average taxable capacity are provided equalisation grants to bring them up to the average level. The interesting part of the Canadian federalism is that both the number of tax bases to be included for estimation of taxable capacity using the representative tax system approach and the way in which they are included have changed. In Canada, all major minerals are assigned to the provinces; if this base is included fully in the calculation of taxable capacity, even an affluent province like Ontario becomes eligible to receive grants. Therefore, it was decided to include only one half the base from oil revenues while estimating the tax base. Indian system of equalisation comes nowhere close to Canada. There are a lot of lessons India can learn on designing and implementing specific purpose grants. Under the Canada Assistance Plan, there are only three specific purpose grants and these are very well designed and implemented unlike in India where there is a large number of poorly designed and implemented schemes.
The Australian system of equalisation is perhaps the most comprehensive one where both differences in revenue raising capacity and expenditure needs are taken account of. The Commonwealth Grants Commission, which is the implementing agency, undertakes a detailed analysis of the capacities and needs based on which transfers are recommended. Furthermore, unlike in the Indian context, the total volume of equalisation transfers are decided in the First Ministers? Conference and the commission only works out relativities for the distribution among the states. In addition, the commission also works out relativities for distributing the profits from GST. There is much that India can learn both in the professional functioning of the commission and in designing the transfer system.
The final essay puts together the contemporary challenges. By and large, implicitly the essay recommends the continuation of the approach of the past finance commissions with small modifications. Given the inequalities on the resources available for spending on physical and social infrastructure, the value of the book could have been greatly enhanced had it ventured into offering future directions to impart stability and dynamism to Indian fiscal federalism.
Despite these comments, the book is a significant contribution to the literature. In an area where much of the analysis is done on the basis of prejudices and judgements, the analysis based on analytical framework using the lessons from first and second generation theories of fiscal federalism and intergovernmental transfers is an important contribution. In an area where there are very few analytical studies, this collection applies the theoretical findings and contemporary best practice experiences to draw lessons for India.
?The writer is director, National Institute of Public Finance and Policy