Rethink the dynamics of India’s fiscal federalism

Rethink the dynamics of India’s fiscal federalism

Rethink the dynamics of India’s fiscal federalism.


The Indian Constitution, tailored as a “holding together federation” with a pro-unitary leaning, emerged as a response to the centrifugal forces and divergent tendencies preceding India’s Independence. Over 73 years, it has exhibited impressive durability. Nonetheless, the shifting landscape of India’s fiscal federalism requires a fresh evaluation. The transition from a planned economy to a market-driven economic system, the evolution from a two-tier federation to a multi-tier fiscal structure following the 73rd and 74th Constitutional Amendments, the replacement of the Planning Commission with NITI Aayog, the enactment of the Fiscal Responsibility and Budget Management (FRBM) Act, the Goods and Services (GST) Act led by the GST Council, and the increased use of cess and surcharges influencing the divisible pool’s size—these factors have reshaped India’s fiscal environment, producing varying effects on its federal structure. I present four key concerns for examination.


GS-03 (Indian Economy, Growth and development)

Mains Question:

  • Discuss the evolution of India’s fiscal federalism in the backdrop of changing economic paradigms and constitutional amendments. 150 words.

Dimensions of the Article:

  • Equitable Intergovernmental Transfers
  • Prioritizing Equity
  • Rethinking Powers and Responsibilities
  • Balancing Third-Tier Governance
  • Transparency in Off-Budget Borrowing

Equitable Intergovernmental Transfers:

  • The intergovernmental transfer system in India should embrace a more equitable outlook. Although market-driven growth processes generally favor the well-off, the Indian experience diverges remarkably.
  • Chancel and Piketty (2019) estimate that the top 1% of earners in India commanded under 21% of total income in the 1930s. This sharply declined to 6% in the early 1980s, only to surge to 22% during the era of liberalization.
  • Notably, recent tax exemptions and concessions have disproportionately favored the wealthy, shrinking the divisible pool’s size.

Prioritizing Equity:

  • Analysis of per capita income (PCI) convergence among 16 major States from 1970-71 to 2020-21, based on data from Economic and Political Weekly Research Foundation (EPWRF), reveals a growing divergence.
  • The standard deviation of log PCI increased to 0.231 in 2020-21 from 0.186 in 1991-92, indicating a compounded annual growth rate (CAGR) of 0.72%. Conversely, applying the United Nations Development Programme methodology, Oommen and Parma (forthcoming in EPW) argue that the Human Development Index (HDI) among 15 States exhibits convergence during the post-reform era.
  • The standard deviation of HDI dropped to 0.268 in 2018 from 0.611 in 1991. Interestingly, the disaggregated view since 2005, spanning FRBM legislations, illustrates declining convergence with a significant negative CAGR of 2.85%.
  • Prioritizing equity should guide the 16th Finance Commission, with HDI emerging as a potential criterion in horizontal tax devolution.

Rethinking Powers and Responsibilities:

  • Revisiting Article 246 and the Seventh Schedule to redefine the allocation of powers, functions, and responsibilities becomes pertinent for several reasons.
  • India’s governance landscape has transformed from post-Independence one-party rule to a true multi-party system.
  • Evolving factors like polity, society, technology, demographics, and development paradigms demand an updated delineation of roles.

Balancing Third-Tier Governance:

  • The Indian Constitution acknowledges the third tier as “institutions of self-government,” yet its proper incorporation into India’s fiscal federalism remains elusive.
  • Lack of uniform financial reporting standards across all government levels is a significant gap that the forthcoming Union Finance Commission must address. Over 3.2 million elected representatives and 2.5 lakh rural and urban local governments form India’s local democratic base. Recognizing their importance and ensuring their effective functioning becomes vital.

Transparency in Off-Budget Borrowing:

  • A reevaluation of off-budget borrowing practices by both Union and State governments is necessary. These borrowings, not covered in the budget but requiring budgetary resources for repayment, often lack scrutiny and transparency.
  • The principles of universality demand that all financial transactions align with budgetary heads. While State public sector undertakings and special purpose vehicles raise funds from markets, repayment burdens often fall on State governments. Addressing off-budget borrowing practices is essential for fiscal accountability.


The ever-evolving fiscal federalism landscape in India warrants a comprehensive reexamination, particularly in light of the 16th Finance Commission. Prioritizing equity in intergovernmental transfers, recalibrating powers and responsibilities, emphasizing the third tier’s role, and enhancing transparency in borrowing practices are key elements of this reassessment. A proactive approach to these challenges will steer India’s fiscal federalism towards greater efficiency and equitable growth.