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Context:
·
In
his last speech, in 1949, to the Constituent Assembly, B.R. Ambedkar sounded a
note of caution about the Indian republic entering a life of contradictions.
“In politics we will have equality and in social and economic life we will have
inequality. These conflicts demanded attention: fail to do so, and those denied
will blow up the structure of political democracy”, he warned, though
Jawaharlal Nehru truly believed that inequities
could be addressed through his tryst with the planning process.
·
A
degree of centralisation in fiscal power
was required to address the concerns
of socio-economic and regional disparities, he felt.
·
This
asymmetric federalism, inherent to the Constitution, was only accelerated and
mutually reinforced with political centralisation since 2014, making the Union
Government extractive rather than enabling.
· While States lost their capacity to generate revenue by surrendering their rights in the wake of the Goods and Services Tax (GST) regime, their expenditure pattern too was distorted by the Union’s intrusion, particularly through its centrally sponsored schemes.
Politicization
of Finance Commission:
·
Historically,
India’s fiscal transfer worked through two pillars, i.e., the Planning Commission and the Finance Commission.
·
But
the waning of planning since the 1990s,
and its abolition in 2014, led to
the Finance Commission becoming a major
means of fiscal transfer as the commission itself broadened its scope of sharing all taxes since 2000 from its original
design of just two taxes; income tax and Union excise duties.
·
Today,
the Finance Commission became a
politicised institution with arbitrariness and inherent bias towards the
Union government.
Indian
Federalism:
·
The
concerns of the founding fathers, addressing socio-economic inequities were
forgotten in the process of ushering in an era of political centralisation and
cultural nationalism that drive today’s fiscal policy.
·
To
be sure, India was never truly federal, it was a ‘holding
together federalism’ in contrast to the ‘coming together federalism,’ in which smaller independent entities
come together to form a federation (as in the United States of America).
·
In
fact, the Government of India Act 1935
was more federal in nature than the Constitution adopted on January 26,
1950 as the first offered more power to its provincial governments.
Reduced
fiscal capacity:
·
The
ability of States to finance current
expenditures from their own revenues has declined from 69% in 1955-56 to less than 38% in 2019-20. While the
expenditure of the States has been shooting up, their revenues did not.
·
They
still spend 60% of the expenditure in
the country, 85% in education and 82% in health. Since States cannot raise tax revenue because of curtailed indirect tax
rights, subsumed in GST, except for petroleum products, electricity and
alcohol, the revenue has been stagnant
at 6% of GDP in the past decade.
Non-divisive
pool:
·
Even
the increased share of devolution,
mooted by the Fourteenth Finance
Commission, from 32% to 42%, was subverted by raising non-divisive cess and surcharges that go directly into the
Union kitty. This non-divisive pool in the Centre’s gross tax revenues shot up
to 15.7% in 2020 from 9.43% in 2012, shrinking the divisible pool of resources for
transfers to States.
·
In
addition, the recent drastic cut in
corporate tax, with its adverse impact on the divisible pool, and ending
GST compensation to States have had huge consequences.
Interest
rate differentials:
·
Besides
these, States are forced to pay
differential interest, about 10% against 7% by the Union for market
borrowings.
·
It
is not just that States are also losing due to gross fiscal mismanagement, increased surplus cash in balance of States
that is money borrowed at higher interest rates, the Reserve Bank of India,
when there is a surplus in the treasury, typically invests it in short treasury
bills issued by the Union at lower interest rate.
·
In
sum, the Union gains at the expense of
States by exploiting these interest rate differentials.
Burden of Centrally Sponsored Schemes:
·
By
turning States into mere implementing agencies of the Union’s schemes, their
autonomy has been curbed. There are 131
centrally sponsored schemes, with a few dozen of them accounting for 90% of
the allocation, and States required to share a part of the cost.
·
They
spend about 25% to 40% as matching grants at the expense of their priorities.
These schemes, driven by the
one-size-fits-all approach, are given precedence over State schemes,
undermining the electorally mandated democratic politics of States.
·
In
fact, it is the schemes conceived by
States that have proved to be beneficial to the people and that have
contributed to social development.
·
Driven
by democratic impulses, States have been
successful in innovating schemes that were adopted at the national level,
for example, employment guarantee in
Maharashtra, the noon meals in Tamil
Nadu, local governance in Karnataka and Kerala, and school education in Himachal Pradesh.
Violation
of constitutional provisions:
·
The
diversion of a State’s own funds to centrally sponsored schemes, thereby
depleting resources for its own schemes, violates constitutional provision.
·
Why
should there be a centrally sponsored scheme on an item that is in the State
list? Similarly, why should the State share the expenditure of a scheme on the
Union list?
·
For
instance, health is on the State list, so why should the Union thrust this
scheme onto States; even on those that are better performing such as Tamil Nadu
and Kerala? It only impedes States from charting their own autonomous path of
development.
Deepening
inequality
·
This
political centralisation has only deepened inequality. The World Inequality
Report estimates ‘that the ratio of
private wealth to national income increased from 290% in 1980 to 555% in 2020,
one of the fastest such increases in the world.
·
The
poorest half of the population has less than 6% of the wealth while the top 10%
nearly grab two-third of it’.
·
India
has a poor record on taxing its rich. Its tax-GDP ratio has been one of the
lowest in the world — 17% of which is well below the average ratios of emerging
market economies and OECD countries’ about 21% and 34%, respectively.
Issues
with India’s fiscal policy:
·
The
Indian elites historically undermined fiscal capacity as they felt threatened
by the political equality offered by the one person-one vote system.
·
That
hollowing out of fiscal capacity continued for decades after Independence,
resulting in one of the lowest tax bases built on a regressive indirect
taxation system in the world.
·
India
has simply failed to tax its property classes. If taxing on agriculture income
was resisted in the 1970s when the sector prospered, corporate tax has been slashed
by successive governments thanks to a pro-business turn in the 1990s. India
does not have wealth tax either.
·
Its
income tax base has been very narrow. Indirect tax still accounts for about 56%
of total taxes. Instead of strengthening direct taxation, the Union government
slashed corporate tax from 35% to 25% in 2019 and went on to monetise its
public sector assets to finance infrastructure.
Conclusion:
·
In
sum, India’s fiscal federalism driven by political centralisation has deepened
socio-economic inequality, belying the dreams of the founding fathers who saw a
cure for such inequities in planning. It has not altered inter-state
disparities either.
·
If
there was anything that alleviated poverty, reduced inequality and improved the
well-being of people, these were the time-tested schemes of State governments,
but they are now under threat.