“Impact of new economic measures on fiscal ties between the Union and States in India”

 

1. Interpretation & Key Theme

  • Central idea:
    • Recent reforms—GST, Fiscal Responsibility & Budget Management (FRBM) tweaks, centrally sponsored scheme rationalization—have reshaped revenue flows, devolution, and expenditure responsibilities between the Union and states, altering the federal fiscal balance.
  • Underlying message:
    • While certain measures strengthen state capacity (e.g., higher devolution via GST), others centralize control (e.g., conditional grants, borrowing constraints), requiring careful calibration to maintain cooperative federalism.

Revision Tip:
Use “devolution vs. centralization” as the recurring motif to gauge each measure’s effect.

2. IBC-Style Outline

Introduction

  • Hook: “When GST debuted in July 2017, states ceded ₹1.4 lakh crore in sales tax autonomy—but in return, they received a share of a unified tax base that’s grown to ₹16 lakh crore by 2024.”
  • Definitions:
    • New economic measures: Goods & Services Tax (GST), Rationalization of Centrally Sponsored Schemes (CSS), Borrowing Framework under FRBM, changes in Finance Commission recommendations.
    • Fiscal ties: structures of revenue sharing (tax devolution, grants-in-aid), expenditure assignments, and fiscal oversight between Union and state governments.
  • Thesis: “While initiatives like GST and Fifteenth Finance Commission recommendations have enhanced state autonomy through higher devolution, revamped CSS and stringent borrowing norms under FRBM have, at times, constrained state flexibility—producing a nuanced shift in the Union-State fiscal balance.”

Body

  1. GST & Revenue Devolution
    1. Unified Tax Structure:
      • Replacement of 17 indirect taxes → simpler compliance but states lost ₹70,000-₹80,000 crore annually (pre-2017 sales tax).
      • Compensation to states at 14% annual growth (2017–22), funded by cess—expiring in 2022 → uncertainty over compensation shortfall (~₹1.4 lakh crore backlog).
    1. Finance Commission’s Devolution:
      • Fifteenth Finance Commission (2020–25) recommended 41% of divisible pool to states (up from 32% by Fourteenth FC), ensuring larger share of GST revenue.
      • Fiscal devolution increased to 3.90 lakh crore in 2023-24, bolstering state budgets.
    1. Dimension: GST reduced states’ revenue autonomy but higher devolution partly offsets losses.
  2. Centrally Sponsored Schemes (CSS) Rationalization
    1. From 66 CSS to 28 Schemes:
      • Consolidation aimed to reduce overlapping programs but increased conditionality—states must allocate matching funds (30-50%) to access central assistance.
      • Example: The National Health Mission now requires 60:40 Centre-State funding in most states, 90:10 in NE—straining weaker state budgets.
    1. Implications for State Priorities:
      • States ceded some discretion over sectors; CSS verticals tie up 20-25% of total state revenue expenditure (2023).
      • Performance-based conditional grants (e.g., “Pradhan Mantri Gram Sadak Yojana 2.0”) reward compliance with central guidelines.
    1. Dimension: Rationalization improves efficiency but centralizes design and reduces state flexibility.
  3. FRBM Act Amendments & Borrowing Limits
    1. Revised Fiscal Deficit Targets:
      • FRBM 2017 amendments linked states’ borrowing to fiscal deficit and debt-to-GDP ratios—states capped at 3% of GSDP, with 0.25% for incentivized reforms.
      • Conditional borrowing linked to power sector reforms, property tax base expansion, etc.
    1. Centre’s Own Borrowing:
      • Central fiscal deficit capped at 3.5% of GDP in 2023-24 → curtails Union’s room for additional transfers.
      • Interest on UDAY bonds and COVID relief borrowing → higher interest outgo, limiting new grants.
    1. Dimension: Stricter borrowing promotes fiscal discipline but limits states’ counter-cyclical capacity.
  4. Role of Finance Commission & Grants-in-Aid
    1. Fifteenth FC’s Special Grants:
      • Population, area, forest cover, fiscal capacity metrics allocate ₹1.2 lakh crore as revenue deficit grants—lifting backward states (e.g., Bihar, UP).
      • Minor state category criteria revised—eight states lose special category status, affecting 90% grant share → tighter budgets for NE states (Arunachal, Manipur).
    1. State Disaster Relief Fund (SDRF) vs. National Disaster Response Fund (NDRF):
      • Shifting more relief burden on states (10% matching) after 2019 amendments.
      • Centre’s discretion over NDRF release → uncertainty for states during calamities.
    1. Dimension: Grants partly equalize disparities but conditionalities and status removals constrain vulnerable states.
  5. Emerging Trends & Cooperative Federalism
    1. Vertical Imbalance & GST Council:
      • While GST Council (65% states, 35% Union weighted voting) embodies cooperative federalism, states voice concerns over cess expiration and compensation gap.
      • Inter-state trade issues (taxing e-commerce, transit) require continuous GST Council interventions.
    1. State Innovation & Own Resources:
      • States tapping non-tax revenues: Telangana’s “TS E-Pass” e-services charging nominal fees, Kerala’s Public Sector Undertakings dividends.
      • Disinvestment proceeds (e.g., HPSEB→HP PowerCorp) used for CAPEX, reducing dependence on Centre.
    1. Way Forward:
      • Strengthening GST compensation cess or alternative grants post-2022.
      • Simplifying CSS guidelines for genuine state autonomy and sunset clauses for centrally designed programs.
      • Revisiting FRBM thresholds during recessions (e.g., COVID disaster) to allow counter-cyclical spending.
    1. Dimension: Balanced growth demands realignment toward mutual respect for state priorities within a unified framework.

Conclusion

  • Summarize: “GST and higher devolution have bolstered state revenues, but tighter CSS conditionalities and FRBM borrowing limits have, in some cases, constrained state flexibility.”
  • Synthesis: “For truly cooperative federalism, India must ensure that revenue-sharing mechanisms provide predictable resources, CSS are streamlined without excessive strings, and borrowing norms accommodate exigencies.”
  • Visionary Close: “By fine-tuning fiscal measures—balancing autonomy and accountability—India can forge resilient fiscal ties that respect both national objectives and state aspirations.”

3. Core Dimensions & Examples

  • GST Devolution:
    • Compensation Shortfall (₹1.4 Lakh Crore) as cess expires in June 2022; states like Kerala faced ₹7,000 crore shortfall in 2022-23.
  • CSS Conditionality:
    • National Health Mission (NHM): 60:40 cost-sharing in most states, 90:10 NE—Manipur’s required ₹300 crore matching strained its ₹7,000 crore budget.
  • FRBM Borrowing Incentives:
    • Power Sector Reform: Punjab, Jharkhand, and UP incentivized to sign MoUs with UDAY for Ø.25% extra borrowing headroom (2021).
  • FC Grants:
    • Revenue Deficit Grants (2021–26): Bihar received ₹32,000 crore, enabling enhanced social spending despite low own revenue base.
  • State Resource Mobilization:
    • Telangana’s Debt Swap (2023): Mobilized ₹10,000 crore from own-state bonds to finance road infrastructure, reducing reliance on Centre.

4. Useful Quotes/Thinkers

  • C. Rangarajan (Economist): “Fiscal federalism is not a zero-sum game; devolution should be growth-augmenting for both Centre and states.”
  • Dr. B.R. Ambedkar: “States should be empowered to formulate policies to suit local conditions—fiscal autonomy is essential for federal harmony.”
  • Arvind Subramanian: “GST is as much a supply-chain reform as a fiscal reform—it needs continuous calibration with state needs.”

5. Revision Tips

  • Frame introduction with one statistic: “GST collection ₹16 lakh crore (2023) vs. pre-GST sales tax.”
  • Memorize one CSS example (NHM 60:40 vs. 90:10) and one FC figure (41% devolution) to illustrate impact.
  • Emphasize the “devolution vs. conditionality” tension to show how cooperative federalism can be strengthened.