IMPACT OF FISCAL FEDERALISM IN INDIAN ECONOMY

ECONOMICS

SUBMITTED TO:
Mr. Abhishek Sinha

Submitted by:
AVINASH SINGH
2015016
III SEMESTER
DAMODARM SANJIVAYYA NATIONAL LAW UNIVERSITY
VISAKHAPATNAM

ACKNOWLEDGEMENT:

I am highly indebted to Mr. However it would not have been possible without the kind support and help of many individuals. I would like to extend my sincere thanks to all of them.I have taken efforts in this project. Abhishek Sinha sir for his guidance and constant supervision as well as for providing necessary information regarding the project. I would like to express my special gratitude and thanks to my friends for giving me such attention and time and helping me in developing the project and people who have willingly helped me out with their abilities. .

Fiscal Imbalances in Indian federalism 4.TABLE OF CONTENT: Acknowledgement Table Of Content Abstract Synopsis 1. References OBJECTIVE OF THE STUDY: The objectives of fiscal policy differ from country to country and from situation to situation. There are four objectives of fiscal policy are equity. Quantum of Fiscal transfers 8. . The government may increase public expenditure or it may reduce taxes to stimulate investment. Finance Commission in India 7. and growth. Macro Political Environment 9. Constitutional provisions for distribution of revenues 5. economic stability and full employment. allocation of resources. Fiscal Federalism in India 2. This would reduce the unemployment and increase demand. Fiscal Decentralization 6. Exploration for Reforms Conclusion. Evolution of Fiscal federalism 3.

fiscal federalism is expected to enable the national and sub-national governments to operate in such a way that leads to efficiency in the use of resources . fiscal federalism is a general normative framework for assignment of functions to the different levels of government and appropriate fiscal instruments for carrying out these functions.SCOPE OF THE STUDY Fiscal federalism in India unlike in many rich countries has to satisfy the competing demands to deliver a number of essential and basic socio-economic services. In fact. RESEARCH QUESTION: (a) How are federal and non-federal countries different with respect to 'fiscal federalism' or 'fiscal decentralization'? (b) How are fiscal federalism and fiscal decentralization related (similar or different)? 1. . continue to remain important in India.not only in terms of the quality of services provided by the various levels of government but also in terms of creating the environment in which all economic agents use resources efficiently. The traditional subjects of concern of fiscal federalism. HYPOTHESIS: 'Fiscal federalism' is a set of principles that can be applied to all countries attempting 'fiscal decentralization'. the fiscal dimensions of federalism are a reflection of the economic federal structure in India. Devolution of taxes and duties still constitutes the most significant dimension of fiscal federalism in India. IMPACT OF FISCAL FEDERALISM IN INDIAN ECONOMY Like in other countries. such as the assignment of taxes and responsibilities as well as the correction of vertical and horizontal imbalances. As a paramount objective.

There are now telltale signs that India is moving away from an era of cooperative federalism towards competitive federalism. EVOLUTION OF FISCAL FEDERALISM The history of fiscal federalism in modern India goes back to the Government of India Acts of 1919 and 1935. Many challenges. due to multi-party polity. 2. the 1935 Act allowed for the sharing of Center’s revenues and for the provision of grants-in-aid to provinces. environmental and political factors combining to produce asymmetrical variations in the country. economic. There is a little work done in the area of environmental policy and its influence on intergovernmental financial relations in India. Within the context of Indian Federalism. The salient features of Government of India Acts of 1919 and 1935 are provided as: 2. if not handled properly. After Independence. and predominance of regional parties at the state level. The economy environment is important in determining contours of fiscal federalism. As a paramount objective. 19191 1 Government of India Act. The existing cultural. therefore. and coalition governments at the centre. While the Act of 1919 provided for a separation of revenue heads between the Center and the provinces. 1919 . social.1 MAIN FEATURES OF THE GOVERNMENT OF INDIA ACT. Bulk of literature on federalism in India had focused on economic aspects of fiscal federalism.not only in terms of the quality of services provided by the various levels of government but also in terms of creating the environment in which all economic agents use resources efficiently. The existence of competition brings-in the importance of transaction cost of coordinating policies and their implementation (a) vertically between different levels of government and (b) horizontally between different units within each of the levels. have the potential to affect harmony within the federal structure of the country. there was a single and same party rule at the Centre and in almost all states for many decades. lie ahead for fiscal federalism in the country. fiscal federalism is expected to enable the national and sub-national governments to operate in such a way that leads to efficiency in the use of resources . what remains important is to take into account the social diversity in a general sense and the diverse ways in which each member state is able to relate to the federal system as a whole and to other member states.Fiscal federalism in India unlike in many rich countries has to satisfy the competing demands to deliver a number of essential and basic socio-economic services.

The Governor had all the powers and the introduction of ministerial government over a part of the Provincial sphere was only an empty shell and was. The diarchy was impracticable and devoid of any real substance. as such. 2. while the Act of 1935 prescribed a federation. because it was optional for the Indian States to join.(1) Relaxation of Central control over the Provinces: The Act of 1919 made a separation of the subjects of administration and sources of revenue into two categories-Central and Provincial. 19352 (i) Federal Scheme: Under all the earlier Acts. in which both the federal and Provincial governments would get definitely demarcated powers by delegation from the Crown. 2 Government of India Act. (2) Diarchy in the Provinces: The Provincial subjects were divided into ‘transferred’ and ‘reserved’ subjects. taking the Provinces and the Indian States as units. 1935 . but on a communal and sectional basis. No popular responsibility was introduced at the Centre and the Governor General-in-council continued to remain responsible only to the British Parliament through the Secretary of State for India. This involved the breaking up of the unitary State into a number of autonomous Provinces which were to derive their authority directly from the Crown.2 THE MAIN FEATURES OF THE GOVERNMENT OF INDIA ACT. The Provinces could run the administration with the aid of revenues they themselves raised. and then building them up into a federal structure. Provincial budgets were separated from the budget of the Government of India. Reserved subjects were to be administrated by the Governor without any responsibility to the Legislature. a failure. The federal structure envisaged by this Act never came into being. It was proposed to unite the Provinces and the India States into a federation under the Crown. and they never gave their consent. the Government of India was unitary. (3) The Indian Legislature: It was made more responsible and bicameral. Even though subjects were divided. Transferred subjects were to be administrated by the Governor with the aid of Ministers responsible to the Legislative Council in which the proportion of elected members was 70 percent. the Central Legislature retained the power of legislation for the whole of India.

To this extent. the Act set up. This is of special interest in view of the fact that the States. and the old Executive Council provided by the Act of 1919 continued to advice the Governor General until the Indian Independence Act.(ii) Provincial Autonomy: Though the part relating to the federation never came into effect. 1949.. and (b) Other than reserved subjects-in which the Governor General was to act on the advice of a ‘Council of Ministers’. The Act of 1935 retained the control of the central government over the provinces in certain spheres requiring the Governor to act without ministerial advice and through him. Appeal. the Indian Constitution that came into existence in 1950 is widely known as basically ‘federal’ in nature.Defence. proceeds largely on the same lines. (v) Federal Court: Consistent with the federal scheme. no Council of Ministers came to be appointed. In fact. but empowered the Governor to authorize either the federal of the Provincial Legislature to enact a law with respect to any matter which was not enumerated in the Legislature Lists. external affairs. The Federal Court had an original jurisdiction to determine disputes between the units of the federation inter se and it was also the Appellate Court on constitutional questions. The allocation of residuary powers of legislation in the Act was unique in the sense that it was not vested in either the Central or Provincial Legislature. (iv)Non-Sovereign character of the Legislature: The legislature powers of both the Central and Provincial Legislatures were subject to various limitations and neither could be said to have possessed the features of a sovereign legislature. whose functions were divided into: (a) Reserved subjects. lay from the decisions of the Federal Court to the Privy Council until such appeal was abolished by the enactment of the Abolition of the Privy Council Jurisdiction Act. 1947. for the first time. the Government of India assumed the role of a federal government visà-vis the provincial government. a Federal Court for India. The executive authority of the Act of 1935 was applied as between the Central government and the Provinces. etc. owing to the circumstances of the times when . A three-fold division was made in the Act of 1935: Federal List. however. the relating to Provincial autonomy was given effect to from April 1937. Provincial List and Concurrent List. but with striking ‘unitary’ features. After independence. left to the Governor General in his discretion. although the Indian states did not come into the fold to complete the federal scheme. of the Secretary of State. (iii) Diarchy at the Centre: The executive authority of the Centre was vested in the Governor General (on behalf of the Crown).

Accommodation was applied to the principles to be embodied in the Constitution. IMPACT OF FISCAL IMBALANCES IN INDIAN FEDERALISM Fiscal imbalance refers to the mismatch between own revenue raising capacity and expenditure needs at different governmental units. Thus. the general presumption would be that the less of imbalance than better. the single most important source of the constituent Assembly effectiveness. In an abstract sense. The members of the Constituent Assembly “skillfully selected and modified the provisions they borrowed” and “applied to their task two concepts – ‘accommodation’ and ‘consensus’. and with the number of states emerging in 1956 in a major way and at subsequent points of time in a minor way. The Finance Commission had played an important role in this evolving structure because resource sharing. However. of necessity. empirical estimates of fiscal imbalances are difficult to derive on the basis of such definitions. 3. with the population increasing from 36. actual elements of federalism as opposed to normative ones. although the very concept of fiscal imbalance has a built-in normative consideration. laid down the manner in which they were to be pursued. Fiscal relations in India had evolved over time through political.10 million 1951 to 1027 million in 2001. it is difficult to find an allocation of revenue sources and responsibilities which is strictly optimal in any sense. is a critical element in the Indian federal system.‘unity and integrity’ of the country was of prime concern3. estimates of revenue capacity or expenditure needs in an absolute sense will depend heavily on the relevant value judgements made and in practice. The profile of Federal India has undergone significant changes over the last six decades. 1966. institutional and functional changes within the ambit of the provisions of Indian Constitution. for. this implies the gap between revenue and expenditure when both revenue sources and functions are allocated between various units of the government optimally. 3 Basu. Consensus was the aim of the decision making process. 1980 4 Granville. based on constitutional division of functions and finances between the Centre and states. .4 While the spirit of accommodation has been evident not only in the finalization of the provisions of Constitution but also in the manner in which Indian union and the constituent states have discharged their responsibilities of serving an ever increasing population within the democratic framework of governance. measurement of fiscal imbalances involves. The Indian Constitution has not only provided a frame work for social and political development but also established the national ideals and.

there are sharp horizontal imbalances among the states in India. The vertical imbalance is further accentuated by the assignment of several responsibilities involving the public expenditure to the states on the grounds that tiers of government nearer to the people would be more sensitive to their needs and thus be better able to discharge such responsibilities. for an example in the Indian context. except under very special circumstances. 5 Estimates o f relative revenue capacity and expenditure needs.. related5. 6 Vithal and Sastry. Since states differ in their resource endowments. probably because it serves to focus on the most lively issue of federal finance that of mismatch in the assignment of taxing powers and expenditure responsibilities. while those at different units at the same level of government (inter jurisdictional) are known as horizontal fiscal imbalances. levels of development and standards of delivery of public services. If the distribution of revenue sources and expenditure responsibilities between the Centre and the States is such that the Centre raises more than it spends while the States spend more than they raise. Adequacy implies sufficient resources for discharging constitutional responsibilities and elasticity implies an expansion of resources in response to the growing needs of Government.  VERTICAL IMBALANCE Vertical fiscal imbalance is usually given primary importance in the discussions of fiscal imbalances. between different States) through the non-neutral incidence of Central revenue and expenditure package. See India (1989).e. the extent of this vertical fiscal imbalance can affect the horizontal fiscal imbalance (i.6 A vertical imbalance between the Centre and states is built into the Constitution by the provisions relating to powers of taxation. but out of the desire to build a common economic space in the country and out of an apprehension that with more powers the states may put up ‘barriers’ within this space. This arises. 2001 . Although these two concepts are identifiable by themselves. Adequacy and elasticity are the essential elements of federal finance.Usually. not out of any consideration of making the centre stronger. however. The practical effect of the division of tax powers has been to deny both these characteristics in the case of states in India. Only when the benefits from the Central expenditure (or grant) exactly match the tax (revenue) collections in each State is the incidence of Central fiscal policy neutral. two types of fiscal imbalances are discussed in the literature. are frequently made. they are. The imbalances at different levels of the government (inter-governmental) are known as vertical fiscal imbalances.

their fiscal situation also shows wide divergences. significant horizontal fiscal imbalance provides an important reason. From the national point of view. The horizontal imbalances have in turn arisen mainly from inter-State disparities in revenue capacity and effort as well as in expenditure needs. Most of these States are also located on the national boundary. which has historically resulted in frequent bouts of social and economic destabilisation. Even the 15 relatively homogeneous States exhibit wide disparities in the level o f economic and social development. generally grouped together as ‘Special Category’ States. due to the geographical and demographic factors. and these have been sought to be corrected through equalising transfers from the Centre. which automatically imply some amount of vertical imbalance. this has also led to increased fiscal dependence on the Centre. it has been considered improper to allow the persistence of large horizontal imbalances. the unit cost of providing various public goods and merit goods is relatively high in these States. As a result. Out of the 25 States in the Indian federation. irrespective of the indicator(s) chosen. their revenue capacity is low compared to their high per capita public expenditures. The latter group is characterised by small industrial sectors and largely unorganized economies. leading to fairly high degrees of fiscal imbalance. Jammu & Kashmir and Himachal Pradesh) form a distinct category. Naturally. the main instrument for achieving this is fiscal transfers from the Centre to states through different channels and the mechanisms as provided in the Constitution. there are both mandatory and enabling provisions facilitating a wide ranging transfer of resources from Union to states. 15 are relatively homogeneous while 10 hill States (seven North-Eastern States. Fiscal transfers to the third tier of government through subsequent Constitutional Amendments (73rd and 74th) had also been envisaged in India. Sikkim. At the same time.    Inter-governmental transfers In order to correct built-in vertical and horizontal imbalances for an even and equitable development of the entire country. . HORIZANTAL IMBALANCES Apart from the number of reasons for the existing vertical imbalance in India outlined above. Accordingly.

(88th Amendment) Article 269: Taxes levied and collected by the Union but assigned to the States. Article 268 (A): Taxes on services shall be levied by the Government of India and such tax can be collected and appropriated by Government of India and the States.4. trades.8 7 The Constitution of India. 2001 . (b) Planning Commission set up by a Resolution of the Government of India dated 15th March 1950 to make an assessment of the material. and to formulate a plan for effective and balanced utilization of the country’s resources. CONSTITUTIONAL PROVISIONS FOR DISTRIBUTION OF REVENUES BETWEEN THE UNION AND THE STATES IN INDIA7 Article 268: Duties levied by the Union but collected and appropriated by the States. Article 271: Surcharge on certain duties and taxes for purposes of the Union. The main pillars of this frame work are: (a) Finance Commission appointed periodically as per Article 280 of the Constitution of India. 8 Bagchi. Article 276: Taxes on professions. Article 270: Taxes levied and collected by the Union and distributed between the Union and the States. The financial provisions of the Constitution are in accordance with what experts would consider acceptable principles for a federal constitution and a desirable attribute of inter-governmental tax power assignment. (c) National Development Council set up in August 1952 to strengthen and mobilize the effort and resources of the nation in support of the Five year plans. an overarching institutional framework had emerged to deal with Centre-state financial relations in India. Article 272: Taxes which are levied and collected by the Union and may be distributed between the Union and the States. Article 275: Grants from the Union to certain States.    Mechanism of Transfers Over the last six decades. intended to address the vertical imbalance in financial resources between the centre and states and to address the horizontal distribution of resources among the states. capital and human resources of the country. callings and employments.

in the absence of scale economies. Planning Commission and the various Ministries of Government of India. qualitatively significant and quantitatively demanding decisions resulting in an increasing level of transfer of resources from the Centre to states. The relative importance to be attached to equity in distribution and efficiency in utilization of resources in determining the respective shares of various states in federal transfers has become a critical factor. the Finance Commission. consequently.  Distribution among the states In the approach to horizontal devolution. over several years. each of the previous Finance Commissions has come up with its own formula. and.9 5. The choice of criteria and the weights assigned by each Commission for the distribution of income tax and union excise duties had regularly provoked not only reaction from the state governments but also invoked critical comments from academics and public finance experts. the abridgement of the scope of Article 275. the extensive use of Article 282 by the Union to make extensive grants to the states as examples of the original constitutional scheme being distorted in actual practice over the years. can result in significant welfare gains as compared to the centralised 9 Bagchi. Resolving the tension between equity and efficiency remains a fundamental challenge in public policy. that has taken. with changes in criteria adopted and with the assignment of weights to different criteria for determining the share of individual states in the total share of Central resources. It is the combination of all three agencies. It cites the under utilization of Article 269 by the Union Government. FISCAL DECENTRALISATION The decentralisation theorem demonstrates that provision of public services by sub-Central governments. namely. 2001 . it is the actual working of the scheme that has revealed deficiencies that seriously detract from much of its supposed merits.However.

the wider choice reduces the welfare cost implicit in the bundling (provided on take it or leave it basis) o f public services. The competitive federalism literature.solution of uniform supply. the degree of decentralisation desired in an economy and the assignment of tax. justifies such transfers as an instrument to bring about ‘competitive equality’ among the jurisdictions (Breton and Fraschini. The social engineering of allocating resources according to the priorities laid down by the planning agency does not recognise consumer choice and fiscal decentralisation implicit in the market economy. this is not to mean that fiscal decentralisation has no role in planned economy whatsoever. However. Decentralised provision of local public goods can supply to the varying preferences of people better and thus enhance social welfare. When the choice set is wider. the larger are the welfare gains from fiscal decentralisation. expenditure and regulatory powers following from it depend upon the envisaged role of the government vis-a-vis the market in allocating resources. . intergovernmental transfers have been justified mainly to ensure equal treatment of equals (or horizontal equity) with regard to their private and public consumption levels (Buchanan. individuals can vote on their feet for the preferred communities. when the government itself directs the allocation of resources. Boadway and Flatters. 11 (Bagchi and Sen. Surely. however. the assignments should be done so as to maximise the net welfare gains. decentralisation in a planned economy can be useful in providing informational input and thus economise on informational costs as also in implementing the programmes efficiently. 1950. 1983). 11 In other words. 1991). Further.10 The more varied is the demand for public services across different jurisdictions. However. when there are significant scale economies or when sub-Central provision o f public services involves transaction and organisational costs. Welfare gains can also accrue from the wider choice implicit in the different tax-benefit packages offered by different jurisdictions. as it happens in a centrally planned or a public sector dominated economy. It is also demonstrated that the welfare gains from decentralisation are inversely related to the price elasticity of demand for public services. However. FINANCE COMMISSIONS IN INDIA: A REVIEW 10 In the traditional literature on fiscal federalism. The fiscal decentralisation on the basis of tripartite division of governmental functions makes an implicit assumption of a market determined allocational process where the governmental interference is confined to the cases of market failure. 1992). the issue of decentralisation is pushed to the background. 6.

For this purpose. 7. have in their approach to transfer of Central resources to the states have appraised the ‘quantitative’ and assessed the ‘qualitative’ aspects of public expenditure.After more than six decades of functioning. not because they accepted this as a constraint imposed by the Constitution or the terms of reference. due from the states. it could be concluded that the mechanisms envisaged in the Constitution have proved adequate for dealing with the consequences of the asymmetry of resources between the Centre and the states. The Commissions and the states have been in agreement that the more important instruments of transfer from the Centre to the states should be the devolution of taxes. 2002). It shows average transfers from Centre to states as percentage of gross revenue receipts of the Centre coinciding with various Finance Commissions. 12 (Srinivasan. as they now stand to cover: (a) State share of Central Taxes and duties (b) Non Plan grants and loans (c) Central assistance for State plans (d) Assistance for Central sector and Centrally Sponsored Schemes. The sum of the above transfers makes up to Gross Transfers. while in the horizontal distribution of these resources among the states equity has to be taken into consideration in view of the disparate levels of development of different states. THE QUANTUM OF FISCAL TRANSFERS The Fiscal Transfers of Federal System. and derived authority from the constitutional provisions to go beyond these terms whenever they felt that an equal treatment between the Centre and the states required this. with the grants-in-aid playing a residuary role.12 The broad approach of the Commissions has been to follow the principles of justice in what is called the vertical division of resources between the Centre and the states. Finance Commissions of the past. . but because they recognized the complementary role of the Planning Commission in the plan process. Having experienced thirteen Finance Commissions in India. The details of the total transfer of financial resources from centre to states as percent of gross revenue receipts of the Centre in recent years. The Commissions did not feel constrained by the terms of reference given by the Centre. The Central Government recovers its loans and advances including interest. the two main instruments they resorted were: (a) progressive formulae for the distribution of the divisible pool and (b) grants-in-aid under Article 275. which gives rise to Net Transfers. They excluded the plan expenditure from their purview.

population is the basic indicator of need for public goods and services and it ensures equal per capita transfers across states. the basic aim of the finance commission transfers in the past has been to correct the differentials in revenue capacity and cost disability factors inherent in the economies of states and foster fiscal efficiency among the states. from Central to the states have been increasing in absolute terms. and (c) fiscal efficiency indicators such as tax effort and fiscal discipline. Among the criteria used for correcting differential fiscal capabilities for enabling poorer states to meet better the needs for public goods services. The result being the states those are tardy in controlling their population gets unduly rewarded. However.27 (XI FC) to 40. but the states have a different perception on this as they feel that it is not only the sums in all but also the manner of transfer. such as population and income. while total transfers after taking into consideration other transfers varies from 35. The criteria used in the past for these purposes can be grouped under: (a) factors reflecting the needs. other transfers consist of grants through Planning Commission and non-plan grants (Non-statutory).20 percent (XII FC). One major area of criticism of fiscal federalism in India is the downfall in the relative share of resources to states. The transfers recommended by successive finance commissions have increased enormously.33 percent (IX FC).57 (X FC) to 14. whether viewed in gross or net terms show that over the decades the transfers.   The Criteria For Devolution Of Taxes And Grants As regards the determination of the inter se shares of the states. and whether as a share of central revenues or of state expenditure. With the untied funds being constantly reduced. The level of transfers.49 percent (IX FC). measured either as distance from the highest income or as inverse. Finance Commission transfers include share in Central Taxes as well as grants. Similarly. Growing disparities in fiscal capacities and levels of services among states upset this stability as widening disparities require larger and more progressive transfers.Total transfers through Finance Commission varies from 22. whether statutory or discretionary. In so far as devolution of central taxes and grants are concerned. (b) cost disability indicators such as area and infrastructure distance. with the central assistance coming down from 26 percent to 23 percent. per capita income distance is the preferred indicator. a further reduction in the share of resources to states has been envisaged. Under the Eleventh Plan. . Planning Commission grants vary from 10.77 (VIII FC) to 26. the overall population criterion does not take into consideration effective family welfare measures adopted by various states. the dependence of states on the Centre has been increasing.

but only at a decreasing rate. It would be prudent to say that the fiscal federalism in India has withstood many changes in the political environment. However. the State Finance Commissions use ‘area’ and ‘remoteness’ as criteria for financial devolution from the state governments to rural and urban local bodies. Similarly. The use of ‘geographical area’ of a state as a criterion for determining its share emanates from the additional administrative and other costs that a state with a larger area has to incur in order to deliver a comparable standard of service to its citizens. population is the basic indicator of need for public goods and services and it ensures equal per capita transfers across the countries. 8. In differential fiscal capabilities for enabling poorer states to meet better the needs for public goods services. giving the nation a Federal character even while several features appeared to be those of a unitary state. but the history of Federal Republic that came into existence in 1950 has not been without challenges. The index of fiscal discipline was proposed by the Eleventh FC with a view to providing an incentive for better fiscal management and was defined as improvement in the ratio of own revenue receipts of a state to its total revenue expenditure in a reference period in comparison to a base period. is expected to lead to hard time for fiscal federalism in the country as charges of favoritism and neglect will be hurled frequently and with greater intensity. MACRO POLITICAL ENVIRONMENT The Constitution of India had ushered a Union of States. The differences in political ideologies. The spirit of federalism has however been kept alive. The past . per capita income distance is the preferred indicator. political and cultural diversity. There are also increasing trends that the same party or coalition may not rule at the centre and the state. overcoming stress and strain inevitable in a nation marked by economic. This index had also been accepted and followed by the subsequent Finance Commissions. the political history of the past sixty plus years in the country is testimony to the fact that multi party coalitions are here to stay both at the centre and state levels.In so far as devolution of central taxes and grants are concerned. The Finance Commissions recognize that the costs of providing services increase with the size of a state. The democratic framework sustained through regular elections to the Union Parliament and State Assemblies has brought India credit in the comity of nations. It is also important to put environmental issues sufficiently along with social and economic issues on the radar screen of political process in India. social.

Inadequate central oversight over states' borrowing resulting in the problem of subnational debt and deficit. The centre should disengage from functions that are better performed at the lower levels of government. Four basic weaknesses of the fiscal federalism as practised in India that seem to have dampened the growth performance of the economy are:  Over-centralisation of economic policies and attempt by the centre to take on too much and micromanage the economy by intruding into areas assigned to the states in the constitution. First.experience of fiscal federalism brings testimony to the facts that ‘equity considerations’ had often preceded over ‘efficiency considerations’ in resource allocations over a period of time. assignment of tax powers needs a fresh look. EXPLORATIONS FOR REFORM The preceding discussion shows that fiscal federalism in India had a positive impact on the performance of the public sector and the Indian economy in the initial period of planning covering the first two plan periods. the scheme of assignment of functions and powers to different tiers of government as contemplated in the constitution should be respected in letter and spirit. stifling local  initiatives and weakening accountability of lower level governments. Faulty design of intergovernmental transfers creating perverse incentives for fiscal behaviour of  recipient governments. The CSSs should be compressed to only a few that represent truly national interests that the states may not be in a position to look after. Secondly. Unfortunately. the growth momentum that the economy had acquired as a result did not last. 9. For SNGs to be accountable and fiscally prudent it is desirable that as far as possible they can meet their expenditures out of revenues they can raise on their . a few suggestions may be offered. The tendency on the part of the centre to micro-manage the economy should cease. The country moved on a slow growth path in the next twenty years. Failure to ensure the development and smooth functioning of a common market in the country and  prevent its segmentation through fiscal and quasi-fiscal actions of governments at both levels. Reforms will be needed on a wide front if these weaknesses are to be removed. However. Growth picked up in the eighties but the chronic imbalances that had developed in the economy threatening stability culminated in the crisis forcing major reforms. with only such modifications as may appear needed to correct the deficiencies and the negative externalities that have surfaced over the years in their operation.

This is particularly important in the context of the constitutional recognition of the third tier of governments. eroding the powers of nation-states on the one hand and of their subdivisions on the other to pursue independent policies of their own. 10. These reforms acquire further urgency with the tensions inherent in federal systems coming under increasing strain as modern technology demolishes frontiers and the world economy gets globalised. To maintain an appropriate balance in the relationship between the centre and the constituent units in a federation. For the federal structure to be stable and flexible. the one cardinal reality that should never be lost sight of is that federalism is the only possible form of government for a linguist country like India. CONCLUSION Ultimately.own at least at the margin. in implementing economic reforms needed to push the economy forward there is no alternative but to reform the fiscal institutions of the federal system and the task needs to be faced upfront by the country. However. Federalism in India as everywhere has to face the awesome challenges of the new millennium. . as most of them lack any substantial revenue sources of their own. attention of both experts and the wider public is imperative all the time. The federal structure needs perpetually to be altered and mended to cope with changing environment and emerging challenges.