ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Federal Transfers and States’ Own Spending on Development Activities in Fiscal Federalism in India

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.

The authors are extremely grateful to EPW’s anonymous referees for their insightful comments and suggestions.

Federalism in India is evolving through institutional and political challenges. Allocation of expenditure and revenue responsibilities to different levels of government is the most fundamental issue in fiscal federalism. In fiscal federalism, fiscal decentralisation enhances the revenue generation capacity along with spending power of the lower level of governments. In the process of achieving sound subnational fiscal health, it is important to ensure proper management of own revenue. Magnitude of revenue receipts determines the level and quality of public spending. A broad overview of states fiscal scenario shows that, over the years, states own source revenue, which is a major source of income, has been growing at a slower pace amidst the growing cyclicality in revenue collection along with squeezing and altering the fiscal space besides exponentially hiking committed spending and debt servicing (Chakraborty 2014; State Finances Report [SFR] various issues).

In the process of bridging the fiscal gap along with a growing revenue crunch and debt servicing obligations, states are increasingly becoming dependent on federal transfers. The resultant increased resource gap or vertical fiscal gap necessitates federal transfers in the path of fiscal management.1 Besides its own revenue cyclicality, variability in the federal funding may further alter states fiscal space. Thus, development spending becomes more vulnerable to the overall revenue uncertainties.

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Published On : 20th Jan, 2024

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