In the second group, a constitution has generally assigned various government economic functions between the central government and the sub-national government, and, to a lesser extent, between the states, or the regions, and the local jurisdictions that operate within them.
By Vito Tanzi
Countries are organised either as ‘unitary’ (France) or as ‘federations’ (India, Brazil, the United States). In the first group, a national or a central government makes the economic decisions for the whole country’s territory. In the second group, a constitution has generally assigned various government economic functions between the central government and the sub-national government, and, to a lesser extent, between the states, or the regions, and the local jurisdictions that operate within them. Generally large countries such as India, Brazil, the United States, Australia and similar ones have chosen a federal structure, one that is assumed to better reflect and satisfy the preferences of citizens in different areas, who may have different cultural backgrounds and economic needs.
In a country as large and as diverse as India, these differences are obviously an important consideration and may require the adaptation of some policies. At the time when the constitutions for federal countries are drafted, it is impossible to anticipate future developments and, thus, the future preferences and needs of the populations. It is, therefore, impossible to allocate, in a permanent and unchanging way, the present and future governments’ responsibilities, among the three government tiers. With the passing of time, and with the changing socio-economic environment of the country and of the world, different needs are likely to arise, needs that were not contemplated at the time when the constitution was drafted.
The new needs will require different allocation of responsibilities than the ones described in the constitution. In all the federations now in existence, there are growing conflicts among the different government tiers related to their specific responsibilities. This has become a common experience. In his 1959 classic and influential treatise, The Theory of Public Finance, Richard Musgrave assumed that it would be more efficient to allocate the redistribution of income and stabilisation of the economy (two recent new government responsibilities) to the central government, leaving much of the allocation of resources (apart from defence spending) to sub-national governments. He believed that this allocation of responsibilities would better reflect the governments’ controls over national tools, such as tax levels, and the incidence of taxes and public spending. However, this was the view of just one influential economist. The constitutions of many countries, including that of India, do not necessarily follow Musgrave’s directive. Over the years, needs that had not been felt in the past have acquired growing importance. This put pressures on the constitutional arrangements determined in the past. For example, both the stabilisation of the economy and the redistribution of the economy had not been important objectives in the past, when the tax burden in India had been only 8% of the GDP. They became progressively more important with the passing of the years, leading to large increases in tax levels and in public spending. This raised increasing questions on which level of government should determine how to use the additional revenue.
The book, Challenges to Indian Fiscal Federalism by TM Thomas Isaac, R Mohan and Lekha Chakraborty, makes a strong case that the Indian central government has been appropriating increasing shares of revenue and of the power of decisions, thus reducing the power to act of the sub-national governments.
This book makes a valuable statistical case for the above view. It will be endorsed by many but will be challenged by others who consider stabilisation as not a neoliberals’ preoccupation. India went through a period when a continuation of its macroeconomic policies could have led to financial crises. The strong merit of the book is having stated its case eloquently and with a lot of statistical support. It has made a strong case that recent national policies diverted resources away from poverty alleviation. But, as is often the case with debates about economic policies, it may not convince those who worry about policies that may lead to financial crises. This is not an endorsement of policies followed in recent years.
(Vito Tanzi is former director of the IMF and deputy minister of finance of Italy)