Fiscal Federalism: UPSC Mains Notes

Fiscal Federalism: UPSC Mains Notes

In News

• Kerala and Tamil Nadu have highlighted growing State debt through White Papers on their fiscal position. The debate has renewed attention towards Fiscal Federalism and the fiscal capacity of State governments.

State Fiscal Framework

• Development Spending: State governments allocate a major share of expenditure towards health, education, agriculture and irrigation sectors.
• Revenue Sources: States finance expenditure through own tax revenues, fiscal transfers, grants and loans from the Union government.
• Fiscal Imbalance: Expenditure frequently exceeds receipts, compelling States to depend on market borrowings for additional financial resources.
• Tax Devolution: Kerala received 1.92 percent of Union tax devolution despite accounting for 2.6 percent of India’s population.
• Revenue Expenditure: A significant share of State budgets supports salaries, pensions and interest payments on outstanding market borrowings.
• Capital Expenditure: Limited fiscal resources restrict investments in infrastructure, higher education, research and public transport development.
• State Development Loans: States borrow through SDLs, paying higher interest rates than the Union government for market financing.

Persisting Issues

• Limited Fiscal Capacity: State development aspirations often exceed available revenues, creating persistent fiscal deficits and rising public debt.
• Revenue Expenditure: High spending on salaries, pensions and interest payments reduces fiscal space for productive capital investments.
• Borrowing Costs: Higher interest rates on State Development Loans significantly increase the long-term debt burden on State governments.
• Investment Constraints: Limited capital expenditure restricts investments required for knowledge-based industries and employment generation.
• Migration Challenge: Inadequate educational and employment opportunities encourage skilled youth to migrate outside their home States.
• Unequal Resource Utilisation: Large domestic savings remain underutilised despite growing investment requirements within several State economies.
• Fiscal Inequality: Weak public finances alongside visible private affluence may further widen existing socio-economic inequalities.

International Best Practice: ChinaChina’s Local Governments: Provinces undertake substantial public investments through coordinated planning with support from the central government.Multiple Financing Sources: Chinese local governments mobilise resources through local government bonds, land sales and financing vehicles.Lower Borrowing Costs: Chinese local governments access domestic savings at significantly lower interest rates than Indian State governments.Coordinated Investment: Central planning enables local borrowing to support long-term infrastructure and economic development objectives.

Way Forward

• Affordable Borrowing: States should access domestic savings at lower borrowing costs to finance carefully planned development projects.
• Capital Investment: Greater fiscal space should prioritise infrastructure, higher education, research and public transport for sustainable economic growth.
• Fiscal Reforms: Fiscal structures should strengthen States’ capacity to mobilise resources without compromising essential social sector expenditure.
• Balanced Development: Public borrowing should support investments that expand welfare, productivity and long-term economic opportunities.
• Efficient Resource Utilisation: Surplus domestic savings should be channelled towards productive public investments instead of remaining underutilised.
• Cooperative Fiscal Framework: Fiscal arrangements should better align State development responsibilities with adequate financial resources and borrowing flexibility.

Source: The Hindu