Introduction
Fiscal federalism entails the division of revenue collection and expenditure responsibilities between different tiers of government. While statutory devolution through constitutional mechanisms like the Finance Commission aims to balance resources, widening structural imbalances continue to undermine states' financial self-reliance and policy autonomy.
Mechanisms Constraining State Fiscal Autonomy
Despite recommendations maintaining vertical devolution at 41%, states continue to face substantial financial constraints stemming from both vertical and horizontal fiscal imbalances.
- Shrinking Divisible Pool: Under Article 270, cesses and surcharges are not shared with states. Their steady escalation to roughly 14–16% of Gross Tax Revenue (GTR) significantly contracts the effective divisible pool, shrinking actual devolutions to approximately 30–31% of aggregate tax collections.
- Erosion of Independent Tax Levers: The implementation of the Goods and Services Tax (GST) subsumed major state indirect taxes (VAT, entry tax, luxury tax). This harmonization largely stripped states of flexible, independent taxation levers to mobilize revenues during economic emergencies or localized shocks.
- Proliferation of Tied Expenditures: The excessive expansion of Centrally Sponsored Schemes (CSS) requires states to commit substantial matching grants from their own revenues. This ties down discretionary funds, leaving limited fiscal space for localized priorities and state-specific developmental demands.
- Rigid Borrowing Restrictions: Stringent borrowing thresholds under the Fiscal Responsibility and Budget Management (FRBM) frameworks—typically capped around 3% of Gross State Domestic Product (GSDP)—alongside strict scrutiny over off-budget borrowings, severely limit counter-cyclical capital expenditure by states.
Way Forward
- Capping Cesses and Surcharges: Introduce a statutory cap (e.g., at 10% of Gross Tax Revenue) on cesses and surcharges, channeling any revenue collected beyond this threshold directly into the divisible pool.
- Rationalization of CSS: Restructure and consolidate Centrally Sponsored Schemes, shifting towards flexible, block-grant funding models based on developmental outcomes rather than rigid input prescriptions.
- Empowering the GST Council: Institute institutionalized dispute-resolution mechanisms within the GST Council to better balance Union policy objectives with state revenue security.
Conclusion
Realizing genuine cooperative federalism requires aligning expenditure responsibilities with adequate, untied fiscal transfers. Establishing predictable revenue-sharing frameworks and respecting state policy autonomy are essential for sustained macroeconomic stability and decentralized public delivery.