Fiscal federalism in India faces a dual challenge — the Centre consolidates its own deficit while states bear the burden of welfare delivery. Critically analyse how Central fiscal consolidation impacts state finances, with reference to devolution, grants, and off-budget liabilities.

Question

PocketIAS · Accepted Answer

Introduction

India’s fiscal federalism is marked by an asymmetry: the Centre drives fiscal consolidation, while States shoulder major welfare and development responsibilities, creating tensions in resource adequacy.

Impact through Devolution

Vertical Imbalance persists as the Centre retains buoyant taxes while States have limited tax autonomy
Although the Finance Commission recommends ~41% devolution, the effective share is diluted by the rising use of cesses and surcharges (not shareable)
Leads to reduced untied funds for States, constraining fiscal flexibility

Impact through Grants

Shift from formula-based to discretionary/centrally sponsored schemes (CSS) increases conditionalities
CSS often require matching contributions, straining State budgets
Decline in untied grants limits States’ ability to address region-specific needs

Off-budget Liabilities and Burden Shifting

Centre’s use of off-budget borrowings (e.g., through PSUs, special funds) improves headline deficit but shifts liabilities indirectly
States face pressure to undertake similar practices (DISCOM losses, guarantees), worsening fiscal risks
In sectors like power and food, States bear operational and financial burdens

Expenditure Responsibilities Mismatch

States account for higher share of social sector spending (health, education, welfare)
Central consolidation often results in reduced fiscal space for States without commensurate reduction in responsibilities

Implications

Rising State deficits and debt levels
Compression of capital expenditure at State level
Weakening of cooperative federalism and fiscal autonomy

Way Forward

Reduce reliance on cesses and surcharges to protect divisible pool
Increase share of untied transfers and flexible grants
Strengthen Finance Commission role in addressing vertical imbalance
Enhance State tax capacity (GST reforms, widening base)
Improve transparency by including off-budget liabilities in fiscal reporting

Conclusion

Central fiscal consolidation, while necessary, has spillover effects on State finances, necessitating a more balanced and transparent fiscal federal framework to sustain cooperative federalism and effective service delivery.

✍️ Practice Mode

Write. Evaluate. Improve. Repeat.

The model answer is ready.

Comments (0)