Federalism and Fiscal Transfers in India

Abstract India’s Constitution provides for a federal framework consisting of central, state, and local governments. By constitutional design, the collection of revenues is relatively more centralized while expenditure responsibilities are relatively more decentralized. In India, states differ widely in their fiscal capacities and initial conditions relating to the size and composition of the population and their relative needs. A sound system of fiscal transfers should be able to resolve both the vertical and horizontal imbalances. Under constitutional provisions, this task has been entrusted to the Finance Commission, which is constituted with an average periodicity of five years. This volume provides a critical overview of the recommendations of fifteen Finance Commissions covering the period from 1951 to date. It also provides an analysis of the theoretical foundations of fiscal transfers that would serve the objectives of equity, efficiency, and stability, and examines in this context trends in fiscal transfers in India and their shortcomings. This volume also analyses the interdependence between fiscal transfers and fiscal sustainability and the evolution of Fiscal Responsibility legislation for the central and state governments. The second edition of the volume provides an updated review of the recommendations of the three most recent Finance Commissions, namely the Thirteenth, Fourteenth, and Fifteenth Commissions. It comments on the salient issues before the Sixteenth Finance Commission and the future of fiscal federalism in India. It emphasizes the principle and role of the equalization approach for determining inter-state sharing of resources.