Fiscal Federalism amidst Coalition Politics - UPSC

Fiscal federalism amidst coalition politics is a complex and dynamic issue in India. Fiscal federalism refers to the financial relationships between different levels of government—central, state, and local. When coalition politics come into play, where multiple political parties form alliances to govern, it can complicate these financial relationships. Each party in the coalition may have different priorities and demands, making it challenging to create and implement cohesive financial policies. This situation can lead to debates and negotiations on how resources are allocated and spent, impacting everything from development projects to social welfare programs. Understanding this interplay is crucial for grasping the broader economic and political landscape of the country.

Tags: GS- 2,Polity & Governance- Federalism– Cooperative Federalism– Centre-State Relations– Dispute Redressal Mechanisms

Table of Contents

Context:

Fiscal federalism is crucial for balancing the financial autonomy of the central and state governments in India.
It ensures equitable resource distribution, strengthens democratic governance by promoting local decision-making and accountability, addresses regional disparities, and fosters cooperative federalism.

Significant Reforms:

Recent reforms have significantly altered fiscal relations:
- Abolition of the Planning Commission: Replaced by NITI Aayog.
- Constitutional Amendments for GST: Facilitating a uniform tax system.
- Increased Tax Devolution: Based on the recommendations of the Fourteenth Finance Commission.

Union Budget 2024-25:

The budget emphasises achieving “developed-country” status by India’s centenary, highlighting the need for cooperative federalism.
It accommodates demands from coalition allies to ensure political support, addressing the challenges inherent in a coalition democratic system.

Constitutional Provisions Related to Centre-State Financial Relations:

Constitutional Framework (Part XII):
- The Indian Constitution delineates the distribution of taxes, non-tax revenues, borrowing powers, and grants-in-aid between the Centre and States through Articles 268 to 293.
Article 269A (Goods and Services Tax – GST):
- Introduced by The Constitution (101st Amendment) Act, 2016, Article 269A mandates that GST on inter-State trade or commerce is levied and collected by the Government of India, with the tax divided between the Union and States as provided by law on the recommendations of the GST Council.
Article 275 (Post-Devolution Revenue Deficit Grants):
- Grants discretionary authority to the central government to transfer funds to States for specific purposes, ensuring financial support where necessary.
Article 280 (The Finance Commission):
- The Finance Commission, mandated under Article 280, recommends the distribution of tax revenues between the Centre and States, advising on state finances, fiscal discipline, and overall fiscal stability.
The Seventh Schedule:
- Defines taxation powers:
  - Union List: Taxes exclusive to Parliament.
  - State List: Taxes exclusive to State legislatures.
  - Concurrent List: Both can levy taxes on subjects listed; residual powers rest with Parliament.

Challenges in Fiscal Federalism in India:

Declining Share in Gross Tax Revenue:
- Despite recommendations to allocate 42% and 41% of net tax revenue to States, their share of gross tax revenue fell to 35% in 2015-16 and further to 30% by 2023-24.
- For 2024-25, the Gross Tax Revenue (GTR) is projected to grow at 11.7%, raising concerns about adequacy in meeting state fiscal needs.
Erosion of State Tax Autonomy:
- The shift to VAT and GST has reduced states’ ability to set independent tax rates, impacting their capacity to address local economic conditions. Delays in GST compensation disbursements have further compounded this issue.
Reduction in Grants-in-Aid to States:
- Grants decreased from Rs 1.95 lakh crore in 2015-16 to Rs 1.65 lakh crore in 2023-24, reducing the proportion of statutory financial transfers relative to gross tax revenue from 48.2% to 35.32%.
Increasing Tax Collection Under Cess and Surcharge Categories:
- Revenue collected through cess and surcharges, excluding GST cess until June 2022, has increased significantly, impacting the states’ share of gross revenue.
Financial Centralisation Concerns:
- The Union government’s use of Centrally Sponsored Schemes (CSS) and Central Sector Schemes (CS) as direct financial transfers to States influences their fiscal priorities.
- Allocation for CSS rose from Rs 2.04 lakh crore to Rs 4.76 lakh crore between 2015-16 and 2023-24, creating disparities between wealthier and less affluent states and influencing their fiscal liabilities.

Issues Surrounding Wealthy vs Less Wealthy States:

Disparities in CSS Implementation:
- Implementation of Centrally Sponsored Schemes (CSS) reveals disparities among states.
- Wealthier states can independently fund matching grants, whereas less affluent states must rely on borrowing, increasing their fiscal liabilities.
- This disparity exacerbates inter-state inequality in public finances.
Larger Financial Powers of Union Government with Limited Expenditure Responsibilities:
- Despite transferring less than 50% of gross tax revenue to states, the Union government maintains a significant fiscal deficit of 5.9% of GDP.
- This setup grants substantial financial authority to the Union while limiting its expenditure obligations, thus restricting state fiscal autonomy.

Impact of Coalition Politics on Fiscal Federalism:

Positive Impacts:

Impact on Central Transfers:
- States represented in the coalition can negotiate more favourable terms for revenue-sharing and grants.
- For example, Bihar received Rs 26,000 crore for road projects in Budget 2024-25, and Andhra Pradesh was allocated Rs 15,000 crore for capital development.
Enhanced Bargaining Power for States:
- Coalition governments, dependent on regional parties, provide states with increased bargaining power, allowing for larger shares of central transfers and greater fiscal autonomy.
Focus on Regional Development:
- Coalition governments may adopt policies addressing regional needs, leading to tailored fiscal policies and balanced regional development.
- The Andhra Pradesh Reorganisation Act, 2014, was passed due to coalition cooperation.
Increased Transparency and Accountability:
- The need to maintain coalition partners can promote transparency in fiscal decisions and accountability in public fund usage.
Stability and Long-Term Planning:
- Despite potential instability, coalitions can foster consensus-building and long-term fiscal planning, ensuring stable governance and sustained economic growth.

Negative Impacts:

Fiscal Indiscipline:
- To appease coalition partners, excessive spending and populist measures may be adopted, impacting fiscal discipline and macroeconomic stability.
Delayed Decision-Making:
- Coalition governments often face challenges in reaching consensus on fiscal matters, resulting in delays in decision-making and implementation of reforms.
Uncertainty and Instability:
- The fragile nature of coalition governments can create uncertainty in the fiscal environment, potentially discouraging long-term investments and planning.
Potential for Misuse of Funds:
- Pressure to satisfy coalition partners can lead to misuse of funds and corruption.

Way Forward:

Promote Competitive Federalism:
- Should be encouraged alongside cooperative federalism, utilising benchmarking, performance indicators, and incentive-based resource allocation to foster competition and efficient fund allocation.
Reform the Finance Commission and Tax Sharing Mechanisms:
- The divisible pool should be redefined to include IGST fully, and criteria for horizontal devolution should be revised to fit the consumption-based tax system.
Enhance the Institutional Framework for Fiscal Federalism:
- Establish a formal relationship to coordinate decisions on the divisible pool and its distribution.
Empower the Inter-State Council for dialogue and consensus-building on fiscal matters.
- Align FRBM provisions for central and state governments, maintaining fiscal discipline while allowing flexibility.
Improve Fiscal Transfers and Grants:
- Redesign Article 275 grants considering the GST compensation law. Restructure intergovernmental transfers to promote equity and address fiscal imbalances.
- Establish clear guidelines for distributing central funds, grants, and subsidies to ensure transparency and reduce discretionary powers.
Implement Robust Anti-Defection Laws:
- Strengthen and enforce these laws to prevent political horse-trading, ensuring stability and consistency in fiscal policies.
Strengthen State and Local Government Autonomy:
- Devolve more fiscal powers to states and local bodies, enhancing their flexibility in revenue generation, expenditure planning, and borrowing limits.
Promote Cooperative Federalism:
- Introduce incentives for states to collaborate and share resources for regional development.
- Establish regular dialogue mechanisms between central and state governments on fiscal issues.
Address Structural Issues in Fiscal Federalism:
- Consider reforms to Articles 246 and the Seventh Schedule to redefine power divisions between central and state governments. Address off-budget borrowings to increase transparency.
Enhance Capacity Building and Long-Term Planning:
- Enhance state fiscal management capacity through training, knowledge-sharing, and technical assistance.
- Promote long-term policy stability by avoiding frequent changes and ensuring continuity across political transitions.

UPSC Civil Services Examination, Previous Year Question (PYQ)

Prelims:

Q. Which one of the following in Indian polity is an essential feature that indicates that it is federal in character?

The independence of the judiciary is safeguarded.
The Union Legislature has elected representatives from constituent units.
The Union Cabinet can have elected representatives from regional parties.
The Fundamental Rights are enforceable by Courts of Law.

Ans: (a)

Mains:

Q:1 The concept of cooperative federalism has been increasingly emphasised in recent years. Highlight the drawbacks in the existing structure and the extent to which cooperative federalism would answer the shortcomings.

Source: BS

FAQs

Q: What is fiscal federalism?

Answer: Fiscal federalism refers to the way financial responsibilities and resources are shared between different levels of government, such as central and state governments. It involves how taxes are collected and how funds are allocated for various services and projects.

Q: How does coalition politics affect fiscal federalism?

Answer: Coalition politics, where multiple political parties share power, can complicate fiscal federalism. Different parties may have varying priorities and demands, which can lead to disagreements on how funds should be distributed or managed, impacting the efficiency of financial policies.

Q: What are the challenges of fiscal federalism in a coalition government?

Answer: Challenges include coordinating between different levels of government, managing conflicting interests, and ensuring fair allocation of resources. Coalition governments may face difficulties in reaching consensus on budgetary allocations and financial reforms, leading to potential inefficiencies.

Q: How can coalition governments improve fiscal federalism?

Answer: Coalition governments can improve fiscal federalism by fostering better communication and cooperation among different parties, establishing clear guidelines for financial management, and focusing on common goals. Creating transparent processes for fund allocation and addressing the needs of various regions can also help.

Q: What impact does effective fiscal federalism have on citizens?

Answer: Effective fiscal federalism ensures that resources are allocated fairly and efficiently, leading to better public services and infrastructure. It helps in addressing regional disparities and improving the overall quality of life for citizens by ensuring that both central and state governments can effectively manage and fund essential services.

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Fiscal Federalism amidst Coalition Politics – UPSC – Edukemy