Impact of new economic measure on fiscal ties between the union and states in India

The new economic measure has a major impact on the fiscal ties and distribution of the tax revenues between the union and states in India.  As per the new economic measure, Goods and Service Tax in India is set to come into effect as one single nation-wide VAT system at the rate of 0% to be levied on goods and services of mass consumption with no exemptions or zero rating for Central Sales Tax (CST) in the states.  This new economic measure raises some important questions for the state governments about how they will finance their public expenditure in coming times.

After India achieved its Independence, the Indian constitution prescribed for federal structure of government and defined fiscal relations between Centre & States. It ensured distribution of powers through central, state and concurrent list which also divided the taxing and expenditure power between Centre and states. The Constitutional Amendment Act,1956 empowered states to impose sales tax under Central Sales Act 1956. The constitution also provided from distribution of net proceeds of taxes between centre & states & allocation between states based on recommendation of Finance Commission. Taxation power and devolution of its revenue between centre & states are governed by list of constitutional articles such as Article 268 -271.This tax arrangement between centre has been dynamic and has been amended from time to time as per requirements. e.g. 80th constitutional amendment 2000 to change tax arrangement between Centre & state & 88th Amendment 2003, introduced service tax to be collected & appropriated by centre & states (Article 268-A). Also Temporary constitutional body like Inter State Council has also been used to examining and resolving fiscal relations between centre & state through mutual consensus. Apart from constitutional provisions, the Central government also established Planning commission which was a non-statutory body for devolution for socio economic planning of states and devolution of revenues to states in form of discretionary aid. The devolution and transfer to states mainly comprised of states share in taxes, grants in aid and loans to states.

However fiscal federalism in India suffers from several issues. Division of financial resource among states and centre is complicated and has made states financially dependent on centre. Moreover with inception of LPG policy since 1991 reforms the government responsibility has been more prone to ensure essential services to its citizens. But post reform era also witnessed rise income inequalities among states which caused regional imbalances and states & central government schemes failed to ensure necessary services. Accompanies with central biases in grants in aid, the vertical devolution of funds has become disputed. The current government has introduced a series of reforms to address the issues.

Some Recent reforms

NITI Aayog replaced Planning Commission
A nation like India not only requires fiscal federalism to meet to need of the governments but also cooperative federalism to address some complex common problems. However the planning process remained centralized with inception of Planning commission which proceeded with top down approach and one size fit all formula. Moreover the state did not had any direct say in policy planning by the planning commission. As a result the plans failed to address diverse regional issues in the country.
Hence planning commission was replaced by NITI Aayog to inculcate the spirit of cooperative federalism in India through active involvements of all state governments & structured support initiatives and mechanisms with the States on a continuous basis, recognizing that strong States make a strong nation. It focusses on decentralized approach and recommends for resource allocation of states based on their respective needs and reduces the discriminatory tendencies of centre to allocate funds to states.

Adoption of recommendation of 14th Finance Commission
Previously portion of tax devolution from centre to states remained at 32%a and several states complained for fund crunches. The 14th FC recommendations included to increase this share to 42%. Acceptance of this recommendations has not only made states greater access to financial resources but ensured for the first time that public expenditure is the jurisdiction of the states and they are the power to influence their own fiscal destinies and government services. Moreover the recommendations ensures good amount of devolution from state government to local bodies and clarity of flow of fund to them.

Restructuring of Central Sponsored schemes
The Central sponsored schemes covers several areas of state subjects which are crucial for realising national development goals. These schemes are implemented by state government based on in guidelines of Union Government. However a number of CSS often overlapped with each other and its rigidity and centralized tendency prevented it in addressing regional needs.

The Union government has reduced CSS from 66 to 28 umbrella schemes. Reduction of schemes with increased devolution helps the state government to address the several areas effectively without being dependent on centre . Also flexibility has been inculcated in these schemes to allow state government to design them as per their requirements in order to improve their efficiency.

Allowing state entities to borrow directly from ODA partners.
Infrastructure development forms a key to addressing regional disparities but centre control over funds and insufficient allocation delayed its development. Recently the states governments have been permitted to borrow directly from bilateral official development partners like JICA for implementation of critical infrastructure schemes. External borrowing by states is unlikely effect the central grant for welfare schemes.

Goods and service Tax
Multiplicity of Central & states indirect taxes prevented the development of a national market. The Goods and Service Tax offers create a Pan India market by subsuming different indirect taxes by implementing uniform taxes for different category of goods across India. The tax reform lead to creation of a GST council consisting of members from Union and state governments where they together determine the GST rates. The council provides greater say of states as Union Government has only a third of say in the council. This is for the first time that states are having a say in determination of central taxes.

Demonetisation & schemes like Make in India
Demonetisation was introduces to eliminate black money hoarded in form of cash. As per IT department it has showed a growth in tax collection and widening of tax base. Increase tax collection makes more money for devolution to state governments. Demonetization complemented Jan Dhan Scheme and promoted financial inclusion and formalization of economy.
The government has introduced Make in India scheme to set up manufacturing units in India. Setting up manufacturing units in states will boost GDP and creation of employment opportunities in states.

Issues & Challenges
While the said reforms indeed provide greater autonomy to states it also suffers from several flipsides. Replacement of Planning commission by NITI Aayog does away the incentives in form of plan grants to better performing states. The adoption of 14th Finance commission recommendation abolishes the backward region grants funds. Hence poorer states like Bihar which got a significant share of the fund are suffering due to loss. While GST provides greater say to states it adversely affect their autonomy of determining taxes falling in state list. Also earlier states fixed tax rates taking the spending requirements & revenues which is unlikely to happen now as a result some states are likely suffer losses. Also presently centre and most of the states are ruled by a single political party. When there is a regime change at centre and states in future conflicts may arise. Large number of states resorting to extra commercial borrowings will make difficulty in meeting Fiscal deficit targets. Schemes like Make in India is likely to benefit developed states and poor states would continue to lag behind./Impact of new economic measure/


 The boost in consumption will provide the fast-pace growth that will help make up for the slow speed of structural reforms like GST and demonetisation.

 The boost in consumption will provide the fast-pace growth that will help make up for the slow speed of structural reforms like GST and demonetisation.

 Thus, there is a necessity for the government to intervene, to increase the size of the formal economy. Some of the measures that can be taken are:

 Financial Inclusion – Access to formal credit, banking facilities and impart financial knowledge. The recent push for promoting digital cashless economy, Schemes such as Jan- Dhan Yojana, Bank Mitras, Lead Bank Scheme, and Priority Sector Lending are good steps by the government towards promoting formal economy.

 Land and Tax Reforms – The current laws encourage firms to remain small and does not provide them an incentive to grow. For example: Raising the number of workers in a firm requires government permission which is time consuming and complicated process.

 Increase connectivity – The high cost of urban living does not promote labour intensive firms, while poor connectivity reduces possibility of promoting hub and spoke model.

 Improve quality of human capital – Boosting education and skill levels will provide the necessary foundation for the formalisation of the economy. The SSA, Mid Day Meal Schemes, SWAYAM, Skill India Mission is some good initiatives by the government.

 Better access to markets and price discovery – It will set a precedent in the formalisation of the agriculture sector which provides the largest informal employment./Impact of new economic measure/

 India’s ongoing cyclical upturn getting a hand from structural tailwinds. The structural story will be supportive of long-term growth prospects, provided the demographic dividend is harnessed effectively and productivity continues to improve on timely reforms.

 For long the Indian administration has separated the domains of strategic diplomacy and trade facilitation. However, the new government is actively working to bring the two under one umbrella knowing well that ‘economic diplomacy’ is crucial to regaining India’s growth./Impact of new economic measure/

 India has to improve its infrastructure so that it can attract more foreign bigger companies in India is presently known as one of the most important players in the global economic landscape. Its trade policies, government reforms and inherent strengths in the economy have attributed to its standing as one of the most sought after destinations for foreign investments in the world.

 Also, technological and infrastructural developments which are being carried out throughout the country augur well for the trade and economic sector in the years to come./Impact of new economic measure/

 Also, the ‘Make in India’ initiative undertaken by the Government of India is likely to bring about positive economic reforms into the country as well as encourage more domestic investments in the next few years. We must remember if India’s economy is strong then the Indian Government has more space to manoeuvre its economic diplomacy to its advantage.

 We see India’s ongoing cyclical upturn getting a hand from structural tailwinds. The structural story will be supportive of long-term growth prospects, provided the demographic dividend is harnessed effectively and productivity continues to improve on timely reforms./Impact of new economic measure/

 Over the last twenty-five years, as a result of the launch of the new economic policy and its continuation, the Indian economy has undergone significant improvement. Currently, India is one of the fastest growing economies in the world.

 India will grow as the second largest economy by 2050. At present, the country is categorized as an Emerging Market Economy (EME) along with China, Brazil, and Russia etc. Even in the current phase of the global economy, India’s macroeconomic performance is comparatively better./Impact of new economic measure/

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