Strengthening Federalism

Prime Minister Narendra Modi, as was visible during his tenure as chief minister of Gujarat, is an advocate of greater autonomy for states in terms of how they want to design their development programmes and spend their share of taxes. In fact, he has even argued in the past for state governments to be given the right to collect income tax.

Against this backdrop, the new terms of reference communicated to the 15th Finance Commission suggest to consider carving out a separate fund from the divisible pool of taxes to be specifically earmarked for internal security and defence-related spending—something that is constitutionally a central government responsibility.

The RBI’s latest report on states’ finances already shows that there is an increase in states’ indebtedness, with inter-generational consequences and sharp retrenchment in development expenditures.

Debt has risen persistently since 2015-16, led by schemes like UDAY. Non-development expenditure rose sharply during 2017-18 in a break from the past, led by committed expenditures such as salaries, pension and interest payments.

Financing via market borrowings is slated to go up. Debt liabilities rose through 2016-19 and are likely to remain around 25% of GDP in 2019-20, making sustainability of debt the main fiscal challenge.

Key Issues:

  • What is the state of the states’ finances?
  • What is the impact of the new terms of reference for the 15th Finance Commission on centre-state fiscal relations?
  • What are the states’ fiscal challenges and what do these mean for the ongoing economic slowdown?