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Re-examining Vertical Sharing and Horizontal Distribution of Fiscal Resources in India
Previous efforts to decompose intergovernmental transfers made by the Twelfth and Thirteenth Finance Commissions into vertical and horizontal components estimate the extent of horizontal fiscal equalisation achieved through transfers at around 90%. But other channels of central transfers and spending, mostly bypassing state budgets, also have implications for regional welfare and horizontal fiscal equalisation. A comprehensive view is preferable for all central transfers and spendings having implications for regional welfare in examining vertical sharing and horizontal fiscal equalisation in India. Some methodological concerns over the decomposition of central transfers into vertical and horizontal components are addressed.
This paper is based on an extension of the data set created as a part of my doctoral thesis submitted to the Indian Institute of Management, Ahmedabad. I express sincere thanks to my thesis adviser Ravindra H Dholakia for his feedback on an earlier version of this paper. I am also grateful to the anonymous reviewer of this paper for the valuable comments provided. All errors and omissions are my own responsibility.
Intergovernmental transfers made to correct vertical and horizontal fiscal imbalances are well accepted in the theory and practice of fiscal federalism (Buchanan 1950; Oates 1968). In India, the centre collects about 63%–64% of the combined revenue receipts on average but incurs about 43% of the combined expenditure; state governments collect only 36%–37% of the combined revenue receipts but incur around 57% of the combined expenditure. In many poorer states the tax base is lower, which leads to horizontal fiscal disparities between states.
Recognising these fiscal imbalances, the Constitution makes it compulsory for the centre to share central taxes with states. Every five years, a finance commission is constituted to recommend the quantum and criteria governing the sharing of central taxes among the central and state governments. Recently, studies have attempted to analyse the transfers into their vertical and horizontal components and to measure the extent of horizontal fiscal equalisation achieved through these transfers. Rangarajan and Srivastava’s (2008) is the first such study; it estimated that transfers awarded by the Twelfth Finance Commission addressed nearly 88% of the existing horizontal fiscal disparities, while 50% of the transfers were devoted for addressing the vertical imbalance. Similarly, Srivastava (2010) showed that transfers recommended by the Thirteenth Finance Commission addressed nearly 90% of the horizontal fiscal disparities that prevailed before the transfers while devoting 54% of the transfers for addressing the vertical imbalance.
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