Context

The relationship between the Union government and the States in India has long been a subject of scrutiny, especially concerning financial transfers. Over the past decade, there has been a discernible trend of the Union government reducing financial allocations to the States, despite recommendations from successive Finance Commissions to increase devolution. This divergence between recommendations and actions has raised questions about the principles of fiscal federalism and the equitable distribution of resources among States. 

Financial Transfers and Devolution: A Discrepancy

The Fourteenth Finance Commission made a landmark recommendation to increase the share of Union tax revenues to be devolved to States from 32% to 42%. This move was hailed as a significant step towards empowering States with greater fiscal autonomy. However, despite these recommendations, the Union government has been steadily reducing financial transfers to the States, raising concerns about the commitment to fiscal decentralization. This reduction in financial transfers is particularly striking given the substantial increase in the Union government's gross tax revenue over the same period.

The discrepancy between the recommendations of the Finance Commissions and the actions of the Union government becomes apparent when analyzing the share of gross tax revenue allocated to States. While the gross tax revenue has more than doubled over the years, the share allocated to States has not increased proportionately. Instead, the Union government has retained a larger portion of tax revenue, citing various factors such as collection costs, revenue allocated to Union territories, and expenditures on specific schemes. This trend of diminishing financial transfers has significant implications for the fiscal autonomy and developmental aspirations of the States.

Impact of Cess and Surcharges on Financial Transfers

One of the key factors contributing to the decline in States' share of gross tax revenue is the increasing reliance on cess and surcharges by the Union government. While these revenue streams bypass the recommended devolution to States, they provide the Union government with additional funds to finance its own schemes and initiatives. The proliferation of cess and surcharges, coupled with the Union government's discretion over their utilization, undermines the principles of fiscal federalism by centralizing financial resources and decision-making.

The disproportionate growth of cess and surcharge collections relative to overall tax revenue exacerbates the imbalance in financial transfers to States. As these revenues are earmarked for specific purposes determined by the Union government, States are left with limited flexibility in managing their expenditures. This shift towards cess and surcharge-based revenue generation not only reduces the pool of funds available for devolution but also erodes the autonomy of States in prioritizing their developmental needs. Consequently, the increasing reliance on non-devolvable revenue sources poses a significant challenge to the principles of fiscal federalism and equitable resource distribution.

Centralization of Public Expenditure and Its Ramifications

The decline in financial transfers to States has led to a greater centralization of public expenditure, with the Union government exerting greater control over the allocation and utilization of funds. This centralization is evident in the proliferation of Centrally Sponsored Schemes (CSS) and Central Sector Schemes (CSec Schemes), through which the Union government dictates the terms of funding and implementation. While CSS require States to contribute matching funds, CSec Schemes are fully funded by the Union government, further consolidating its authority over resource allocation.

The proliferation of CSS and CSec Schemes not only diminishes States' fiscal autonomy but also exacerbates inter-state inequalities in resource distribution. Wealthier States, capable of matching Union government funds, benefit disproportionately from CSS, while less affluent States face increased financial burdens. This differential treatment perpetuates disparities in developmental outcomes and undermines the principles of cooperative federalism. Moreover, the discretionary nature of these schemes allows the Union government to prioritize specific regions or constituencies, potentially skewing resource allocation for political gains.

Implications for Fiscal Governance and Cooperative Federalism

The diminishing financial transfers to States, coupled with the centralization of public expenditure, pose significant challenges to fiscal governance and cooperative federalism in India. By retaining a larger share of tax revenue and channeling funds through non-devolvable sources such as cess and surcharges, the Union government undermines the principles of fiscal autonomy and resource equity among States. This trend not only hampers States' ability to address their developmental needs but also erodes their role as equal partners in the federal structure.

Furthermore, the proliferation of CSS and CSec Schemes exacerbates inter-state inequalities and fosters dependency on the Union government for resource allocation. This undermines the spirit of cooperative federalism, which emphasizes collaboration and shared decision-making between the Union and States. To address these challenges, there is a pressing need for greater transparency and accountability in fiscal governance, along with a renewed commitment to devolution and decentralization. Only through concerted efforts to strengthen fiscal federalism can India achieve inclusive and sustainable development for all its constituent units.

Conclusion

In conclusion, the Union government's reduction in financial transfers to States, despite recommendations for increased devolution, raises fundamental questions about fiscal governance and cooperative federalism in India. The growing reliance on non-devolvable revenue sources and the centralization of public expenditure undermine the principles of fiscal autonomy and resource equity among States. To address these challenges, there is a need for greater transparency, accountability, and cooperation between the Union and States. By reaffirming their commitment to fiscal federalism, India can ensure equitable and inclusive development for all its citizens.

Source – The Hindu