Intergovernmental transfers play an instrumental role in shaping the fiscal adjustments and fiscal performance at the subnational level in a federal system like India. Research evidence bears out substitutive or stimulatory effects of federal transfers depending on the nature of transfers. Taking into account the conditional and unconditional transfers, this paper empirically verifies the presence of substitution or stimulation effects on the state-level development spending for 14 major states. The panel cross-sectional–autoregressive distributed lag model test results revealed the area- and sector-specific conditional transfers being stimulative in nature, encouraging states to complement central transfers using their own sources of revenue, while the same is absent for unconditional transfers. Besides, the paper brings out the influence of identity-politics, pre-election tactics, and tactical redistribution to enhance political mileage.
