Can India handle fiscal decentralisation?

Not without strong accountability to the people and budget management by States

The government’s newest catchword when it comes to the Goods and Services Tax seems to be ‘federal’. Finance Minister Arun Jaitley has repeatedly informed Parliament that the GST Council is the first truly federal body in India, where decisions on tax will be taken by the Centre and the States together.

The overall structure of the new tax regime, by dividing the right to tax assessees between the Centre and States, increases the revenue collection responsibilities of the latter when it comes to indirect taxes. This comes on top of the increased devolution of Central taxes — up to 42 per cent — to the States as recommended by the Fourteenth Finance Commission.

The flip side of this increased devolution was that the Centre reduced its spending in several key areas such as infrastructure, health and education, with the argument being that if the States are getting a larger share of Central revenues, then they should also shoulder a higher burden of the expenditure.

This sounds reasonable, but we have to see whether increased decentralisation, as even the GST seeks to do, can work in a country like India.

Insights from IMF paper

A recent working paper published by the International Monetary Fund looks into the merits and demerits of fiscal decentralisation. While the focus of the paper is more general, the findings lend some insight into the specific case of India.

Overall, the paper finds that fiscal decentralisation can strengthen fiscal discipline.

The argument behind this is that local authorities — state governments, in our case —are under stronger pressures than the central government to provide public goods with limited resources. The closer geographical proximity with the population breeds such accountability, apparently. The paper also postulates that local governments have a greater idea of the needs and preferences of their populace. This is a shaky assumption in India, at best.

The authors of the paper, however, say that expenditure decentralisation must be accompanied by revenue decentralisation as well. Between the Fourteenth Finance Commission and the proposed structure of the GST, that part seems to be taken care of. That’s where the positives end.

Not for us?

The first prerequisite for fiscal decentralisation is a strong sense of accountability to the people. In a country where state elections are held every five years, and the population can easily be manipulated into caring more about beef, alcohol, and moral policing than about the provision of basic necessities, accountability seems a moot issue.

The other problem is that fiscal decentralisation requires the States to have strong budget management, something that even the Reserve Bank of India has found is patchy at best.

A 2016 study by the RBI found that while increases in the share of capital expenditure and developmental expenditure were what drive GDP growth in States, their spending has been marked by the dominance of revenue expenditure. In other words, a large part of the spending is unplanned. Further, any improvements in such a scenario have been dispersed and are by no means a country-wide phenomenon.

“Absent these prerequisites, fiscal decentralisation has the potential to trigger major fiscal slippages; in particular, in countries with weak institutions, concentrating authority at the central level facilitates the establishment of processes and controls,” the IMF paper said.

In other words, while fiscal decentralisation, which is only set to increase under GST, may seem a good idea, it is worth looking deeper into whether such a system will actually work in a situation where States seems to lack the adequate budgetary planning and accountability to handle a larger share of revenue and expenditure.

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