The Political Economy of the Indian Fiscal Federation

Abstract:     
This paper performs three empirical exercises to determine the patterns and properties of fiscal flows and mechanisms in the Indian federation as they affect subnational state governments, who carry the major public expenditure responsibility for education and health. Statutory flows from national level to states, defined in both aggregate and distribution between states, were exceeded or equaled in magnitude by non-statutory Plan flows that were variable in aggregate quantum and degree of subordination to distribution by formula. The non-formulaic bargaining margin within these flows is quantified for each year of the period 1951-2007, and estimated to have varied inversely with an index of political fractionalization in the federation. This uncertainty in the predictability of annual transfers provided an unfavourable fiscal environment for enhancing steady expenditure commitments of the kind required for provision of primary education and health. The consolidated fiscal imbalance aggregating across national and state levels is shown to have responded to the national (distinct from the non-synchronous sub-national) electoral cycle, in contrast to the imbalance at national level which did not. Thus, the control constitutionally vested at national level over aggregate state borrowing from financial markets was subject to opportunistic temporal distortions. Finally, the paper examines the major debt dismantling initiative starting 2005 with fiscal correction conditionalities, to reduce the large stock of debt owed by states to national government consequent upon the high loan content of the non-statutory flow. The paper quantifies the extreme variation across states in the fiscal adjustment distance required, as a result of imposing uniform targets on states with widely varying initial conditions. States lacked control over their fiscal environment in the absence of a standing platform whereby the de facto functioning of fiscal arrangements might have been open for continual examination and monitoring by all partners to the federation.

Number of Pages in PDF File: 52

Keywords: political economy, fiscal federation, developmental outcomes, bargaining margin, political fractionalization

JEL Classification: D72, E62, H62

Accepted Paper Series