States (with some exceptions) have played a double game. When presented with autonomy, they have failed to use this in ways that have actively shifted the federal bargain.

A picture of Prime Minister Narendra Modi and Finance Minister Nirmala Sitharaman, talking to each other while sitting on state. Modi is wearing a green jacket and is on the left of the frame. Nirmala is in a red sari, holding a black folder, and is on the right of the frame.Courtesy: PTI
Voices Cooperative Federalism Monday, October 11, 2021 - 15:36

“Everybody loves decentralisation, but only to his level.” This widely cited quote attributed to Raja Chelliah evocatively captures the everyday realities of India’s fiscal federal compact. However, as a long time student of the dynamics of contemporary fiscal federalism in India, I wish to add a minor modification: “Everybody loves decentralisation, but only to his level, and only in a manner and form that is convenient to them!”

Debates on fiscal federalism in India have inevitably focussed on the Union government’s penchant to centralise fiscal powers. But rarely have these debates engaged with the complex political economy that incentivises this centralisation and the state governments’ own complicity in furthering this centralisation. Unpacking these political dynamics of center-state federal relations is crucial, both to developing a more granular understanding of fiscal federal relations, and resolving current disputes.

There is no argument that India’s fiscal federal framework, both in its design and everyday practice, is characterised by what scholars of federalism call a ‘centripetal bias’. This bias is a consequence of a structural imbalance built in to design — the Union government has far greater fiscal powers, to tax, manage debt, acquire assets, whilst state (and local) governments’ have the bulk of expenditure responsibilities. The Finance Commission (FC), which meets every five years, is responsible for correcting this imbalance by determining a tax sharing formula that preserves state fiscal autonomy.

The Union government – centraliser in chief

However, as is well known, the Planning Commission through the practice of transferring plan funds to states and fiscal transfer instruments like centrally sponsored schemes (CSS) and central sector schemes (CS) played a key role in undermining this autonomy, and enabling the Union to encroach on areas relating to the State List and Concurrent List in the Constitution.

In 2015, the Planning Commission was dismantled (and the practice of transferring plan funds to states discontinued), and the recommendations of the 14th FC to increase the state share in the divisible pool of taxes from 32% to 42% was accepted. The stated goal of both these shifts was to restore fiscal balance. However, this was never achieved; central transfers through CSS and CS remain significant, accounting for 30% of total transfers to states, or 2% of GDP (2019-20). Moreover, the states’ share in these CSS was increased from an average of 25% per scheme to 40%, thus further reducing, rather than enhancing state autonomy in budget making.

And most importantly, the Union government carefully avoided fulfilling the true spirit of the commissions’ mandate by increasing levies on cess and surcharges (not shareable with states).  Actual transfers to states as a share of gross tax revenue (GTR) ranged between 33%-35% through the 14th FC period.

One of the most far reaching, yet rarely debated, consequences of this penchant for centralisation was the systematic undermining of an institutional culture to mediate fiscal federal relations. The planning commission’s ‘centralised’ planning regime meant that states had few incentives to build their own planning capacities and place demands on the Centre. With Delhi making plans, state governments lost incentive to build their own capacities. As central schemes proliferated, state planning departments were actively circumvented and planning became a process to be managed between line departments in states and the Union government. Here, too, weak planning capacity at the state level has become the excuse to curtail state flexibility and perpetuate a top-down, one-size-fits-all implementation culture. The result is a vicious cycle in which state governments are cast as mere implementing agents responding to rules and orders from the Union.

Despite complaining, state governments have failed to generate momentum for strengthening federal institutions like the inter-state council. (In fact I have not heard any regional political party demanding the activation of this now moribund, yet constitutionally mandated, council – the product of a political culture I discuss below). The GST council is perhaps the first and only institution where state governments actively came together with the Union to build an institutional culture of deliberation and mediation. But here too the penchant for centralisation has resulted in a wide trust deficit that, for the moment, has undercut its effectiveness.

State governments – reluctant dissenters?

States (with some exceptions) on their part have played a double game. When presented with autonomy, they have failed to use this in ways that have actively shifted the federal bargain. Consider this: the period of deep regionalisation in Indian politics (the era of coalition governments) coincided with increased fiscal centralisation through CSS. According to calculations by the 14th FC, between 2005 and 2011, Union government spending on State List subjects increased from 14 to 20% and its spending on Concurrent List subjects increased from 13 to 17%.

And here’s the puzzle. Since the 1990s, states have actively used their political bargaining power at the Centre to renegotiate their political and economic relations. In 1996, a meeting of Chief Ministers in Hyderabad issued a statement titled “Federalism Without a Centre”, a slogan that gained fame when the scholar, Larwence Saez, used it as a title for his book on the evolving nature of Centre-State relations. But these complaints never translated into a political push for greater fiscal decentralisation.

In fact, when faced with the prospect of greater fiscal autonomy in the early part of 2015 after the Union accepted the 14th FC recommendations, states did everything within their powers to demand CSS be reinstated but with some flexibility! My colleague Avani Kapur and I interviewed several state government stakeholders to understand this. In an ironic twist, we heard some states argue that weak planning capacity meant that states found it easier to invest in social sectors because they come with clear norms and guidelines. Better governed states, particularly southern states, had a different argument. CSS allowed us, they argued, to ring fence money for social sectors. This helps to ensure adequate fiscal space. 

In the end, of course, they got more than they had bargained for as the Union went on to increase their financial contribution to the CSS.

The roots of this double game lie in the political economy, specifically, the attribution effects in politics. In the peak coalition era, as political scientist Louise Tillin’s work has shown, powerful Chief Ministers were deft at leveraging India’s centralised fiscal architecture, claiming credit for central schemes when implemented well and, I would add, blaming the Centre when implementation was uneven. The Centre, too, took advantage of this decentralised political environment to blame states for policy failures, paying scant attention to its own role.

States were also able to use central schemes to their advantage. As Union funding for key social sectors expanded, states began to reduce investments from their revenues in these sectors, substituting investments they ought to have made from their budgets, particularly wages with funds accessed through this. So even though states disliked the centralised approach, the CSS money and ability to deploy it for political attribution mattered. This explains why several states began crying hoarse about the cuts in CSS as soon as the 14th FC mandate was announced.

Afterall, everyone loves decentralisation, but only in a manner and form convenient to them!

And let's not forget that states with the rare exception of Kerala and Karnataka (to a degree) have failed to uphold the federal principle by devolving powers to local governments.

This is not to suggest that centralised transfers have not been used politically by the Union. Studies on planning commission transfers demonstrate this well. The argument is that the centralised nature of fiscal transfers is not a critical bargaining point for political accommodation by States because State’s have chosen to use their autonomy flexibly, for short term gains. I would go so far as to say this is one of the critical weaknesses within the GST bargain too. For fiscally-strapped states, the promise of generous compensation in arriving at the GST consensus overrode concerns of fiscal autonomy. The temptation to succumb to short term gains came at the cost of a carefully-designed GST. Don’t forget that even before COVID-19 and the associated crisis over compensation cess, GST had run into serious challenges ranging from a complex rate structure to the tyranny of the e-way bill system, which contributed to the growth slowdown and associated revenue shortfalls.

But the political terms of India’s imperfect fiscal federal compact are now being actively renegotiated. The presidential character of national politics in India today, aided by technology and new forms of mobilisation, have resulted, as I have argued in a paper with Neelanjan Sircar, in a new politics of attribution that allows the Union government to directly claim credit for implementation success, undermining Chief Ministers. In fact in voter surveys for the 2019 general elections, the Union government — and specifically the Prime Minister — was able to garner credit for implementing schemes, undermining Chief Ministers. Could this be the political moment for deepening fiscal federalism in India?

Yamini Aiyar is the President and Chief Executive of the Centre for Policy Research. Views expressed are the author’s own.

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