NlTl Aayog and !ndian Fiscal Federalism

,..the new NITI Aayoghas to dertne its oi'n

role carcfull!, but qt thesqme time li it its dircctintcrvention itt the Indisneconomy. Il cqn setYe as a

foundation for rcrhinkikg ta,,c

s uthorities fo r s ub-nstionalgovemrrrents, irnprcving the

efrciency of goverumentexperrditurcs al all levels,

.lecentrulizing wherepossible, snd sbeqmlinit g

and integrating the system ofint e r g o| er nmental fi ansfe t s

NDIA'S NEW nationalgovemment, wbich tookoffice in May 2014,took a potentiallymomentous step withthe shuttering of thevenerable Planning

commission. The main premise forthis saep app€ared to be a d€sire tostrengthen the role of the States in lheprocess of economic development.RepreseDtalion ofthe States in the

successor organization, NlTl Aayog, isstronger than in its predecessot but the

sourc€ ofr€al change will be changes inthe way in which Central transfers are

made to the Slaies. This has to be done

in ways thai increase the flexibility and

control of the States, but at the same

time, increase their accountability.Simplicity, timeliness, iransparency,monitoring and evaluation of Centre-State transfers-all need improv€ment.Without these fundamenlal changes,

new thinl l.anks, or claims ofcooperativefederatism, \{rill not rnak€ a difterenceto Indiat economic develoPmenr.

It is natural for a federal syst€m

to have vertical rransfers. The centralgovemment has advantages in raisingfuDds through taxes, whil€ the states

and local govemments have advantages

in making €xpenditures for manypublic goods and services. India

Niwikar Singh

has made, and continues to make,considerable progress in impmvingthe efficiency of its tax system, butmechanisms for expenditures andintergovemmental transfers siill need

significant r€forms.

With respect io transfers, a system

that subsidizes marginal sub-natiomlexDendirures embodies a commonpoil problem.r Cap-fi llrng transfersare an example of this inefficientapproach. On the other hand, transfers

that do nol affect the cost of marginalspending by recipient governmentswill not create distortions: One has tobe caretul here to distinguish between

cases where the goal is to increase

sub-natioml fiscal capaciry, and those

where there is a diverg€nce betwe€n

sub-national and nalional benefits. Asan example of the latter. spillolersacross state boundaries from slate-le!elexoenditures could iustiry transfersth;t change the marginal cost of rhat

spending.

Barry Weingasr and hrs co-aulbors(€.g., Careaga and Weingast.200I)have att€mpted to tackle an evenmore important issue for developitgcountnes, namelythe groMh effects off€deml insaitutions govemingrcv€nueauthority and sharing. At the dskof some ov€rsimplification. we can

distinguish the t\rb sets of questions

Th" ""th.

h.ld" tt "

S*bt lt Singh Aurola Chair of Sikh od Punjabi Studies at UCSC (Universitv of Caufomia' Sanra Cruz) He also

directs rhe Business Managemeni rconomics ?rogram and lhe UaSC South Asian StDdies Initialive. He isa membd of the Advisory

Group ro the Finarce Miniter of tndia on c,20 mare^. Hh cunmr research ropics include enlrcpreneuBhip. infomation techroloSy

and d;velopment, electronic commerce, business stmtegv, political economv, federalism' ecoDomic glos4h and the lndian economv- He

has author;d over I 00 lesearch papers md co-aurtrored ririe books: Joint Ventures, Intemational Investment and Technolosv Transfer;

ih; political Economy orFede;alism in tndia: and waitins ro comecr: rrdia rr Revolution Bnasses the Domesdc Industrv. He las

ako sewed as m adviior for several srartuPs and knowledse serices fims in Silicon Vallev and in India'

52 YOJANA February 2015

aq lollo\s. The standard pubticnnJncr q esrion takes rtre srbnarion,rjunsd,crion s ,ncome as s,ven. andlooks ar ihE rn(enti\e ef;cts of mrassignmenrs and rransi'ers The groq rhperspe.n\ e.\arnines rhe effects ofth.tax and lransfersystenr on incentives to

'ncreas( rn.ome (e g. rhrough pubtiL

or pfl!are tn!esnnenr)

Careaga and Weinsasi(2001) use amodel in which govemInenr decision_makerq can c[h(r capture rents. orncreaie lheir rufi sdrcrion,s in.om.

and hcnce its tax basc. From rhi;pdspe(rj\c, nrr mareinat sub natronajrelenIon rarc ol!//rares levredon rh.sub nationrl lar base comes mto Dla!Acc.rd,n! ro rhs approach, grouri-cnhancrng teJerat s\srems have h,shsub-nalional narginai .erenrion ral;ln the Indian case. this logic mishtsupport a case for modityins rhcrrnrnce ( ornmission transfer formuta.or e!en chanErng rhe assiAnment l]1tax auihorities across differenr tevelsof golenrment to reduce the size of\ ertical rrJnslers Ir atso supse\rsrethrnt ing rh( ,ote znd mechani;;c,,;other rransfer channets in India.

Singh and S nivasan (20l]]re-rmphasized r recurrina idea inrecent discussions of Indian fiscalfederalism, namely, that cenrre_state transfers firough the FinanceCommission, Plannins Commission(now its succcssor. NtTt Aayog) andthe mrn,slfles have ro be looked at rna unifred frJn)cqork. tgnorins many,lelarls and si,nptrtlirs a tor. rhere arcessenlially threc rypcs oftransfersj iiomcurrent revenues as detennined bv theFrnance Commrssron. canital tran'sfersfor linancrng rnvtstmenr I tonnertr thedomrin o hc pldnnrns Cummisslon r.and rransfers for inremrlizinF posihveextcrnalities that onc shte's fisc.lactions may have on other states andlhe Lountr) s uconorn) as a uhotc(currenrl), rhe domarn of cenrr/Ivsponsored schemes).

Follos,ing S;nsh and Srinivasan(2lrll ). rt rs shJlrersonabte ro.rgu. rharl(r)the centre ake tutt responsrhrtrtv tor,inan(ing in\e\rment and operalronalcosrs of projecrs rhar ha\e \pr -overacross stales, regardless ofthe aurhoritvthat implements them (centre oistate). Thc currenl sysiem olcenrraly

YOJANA February 20j5

sponsored schemes, unde. which thecenrre pro!ides paniat iirndinq for thefrolecr's rnveslment cost and for irroperarionrl Lost ior a timrred Derlodhas had rhe unlorrunate efiecl Lhrrprojecrs gerslafled and comDleted. buronce compteted are not tutir urilizedb(cause srares have nor Dro!rde.t rh.needed cosrs oloperaring them once rtnecame thelr ex(lLsive resDons,hir,,viupro\ ide them. Thecentr; assumin;tull linancial responsihitrrv wrlt avoiithis sasl. ( )The NtTt Adyoq serleas a Fund for PubtJ( In!<stmenl rFpt Ifor borh the cenrre and slares Irsshareholders woutd be rhe state andcentral gov.-mments. TheFwd. muchIjke a mulhlarerat de\etoprnenr brnk,would afpraise the projeds proposedIor thetr economrc znd social rerumsas well as feas,bitrry dnd soundness orproposed financing (from rhe centreor state s o\\n resourccs, borronir!fio,n domesrrc and iorergn sorrceiznd capital rransters liom the centreif .eleunr

Houever. NtTtAalos has to rhinkbeyond ils o\tn rote ro (onsrder m,""other slructures of Indian ilderatis;Weingast (1993) introduced the ideauf Market Preser! ina Federati\m(N4PF), defined bv fiie condrtionsl(l)a hierarchy of govemments withdelineated authoriiies (the basis oflederalism ). lt, primary authonryover locat economies lor subnationatgovcrnmentsi (]) a common nationatmarker enlorced b) rhe narronatgovernmenlj (4) hard subnationalgovernmenl budget constraintsr and(5) institutionalized a ocation ofpolitical authority. Earlier. the ideao1 cooperarr!e tcderalism (Wheare.lo5.lr. emphasrzed rhe muluat parnsfrom drrercnr subnarronat rurisdicjronsas qell as subnationat a;d nation2lgo! <rnmcnts qorkina in concertSimila.l). Riker ( tcb4tconcei!ed nrfedcrations as consrituhonai barsainsdesigned to enhance securitv'2ndslability. An alternative appioachslresses the benefts of comDetitionamong suhnational urits, and belweennationa I and subnationat qovemmentsThis compenrion enhances eftrciencvb1 impr,'r1ng rhe rncentrrcs oipolilical leaders to act in the inrerestof their constituents (Tiebout. 19561Brennan and B uc h anan. I980:Breton. l9o5). Breror atso nores thar

competirion amonq governmenrsmay be destabilizina or Iead r.inequitabte outcomes,;nd does noisee it as something that is alwavs bestleft unresrrained t,,tpF encomoassesi,ey aspecrs ot competrri\ e tede;at jshbul goes be)ond jt in ceverat \aa1s.panicrlarly rn condirrons (l) and lt, Ailhc sarne tlme.excett in rheresrncr,onsembodied in llt, rhe vrew of MpFis more sanEuine aboLrt comDerrrionrhan rs Ereron. It enrphasrzes bortr rhcdeLentmlizanon and ihe res,rainr oftheregulatory power of sovemmenls vis-n_v;s the markct. Singh (2008) discussedthe applicability of these ideas in thecontext oflndia and China.

In lederal syslems such as India.sgeneral issues of quaJrry oluovemanc;become inrertlrned urrh rhe fealuresand operation of the hierarchv ofgo!emments The MPF perspe;trvers rhar. given basic good Ao!emance.whar marrers especiatt) is resllidingrnerircrenr governmenr in te r ieren cein lhe marker, and lhe reht kurd offederal rnsLituhons can h; xnDoflantrn achreving thrs. From rhis !ie$Doinr.certain kinds ot decentratizztio. otgo\crnance may becomptemenraD r,,market oriented refonn5 that redrawthe boundary between sovernmenr

To rhe cxrent that lndra,slundamental governancc Droblenrrs one of accountabrtitv. one .,na.gue (Rao and Siosh, i00j) tharIndia's centralized traditio,alaccountabiliry mechanisms. rehrns aqrhe) do on hierarchicar porrriiarinabureaucratic (onrrot and rnonrrorinq.hare bcen ineffertire. A morc robuirfederal strucrure. extendins poliricalaccounlabilily more effectivelv atth€ sub-national level. is irnDona;t roconsrder as a way ot increasing theetnrrency of'go\emance. At rhu samerime. rhe MPF perpective emDhasizesth< imporrance of haring rie rightreslflctronq on the sphere ofaclion ofsuh-narional go'ernments,rs-a,i"

Decentralizahol of go!ernmenr rorrnprove emcrenc! iloes not remo\eall higherJevel governmenroversiohlll certarn indrvrduat rishts a; anational Icvel merir good, rhen thecenlral governmenl can still moniro.lheirsub-national provision toensnre

IE53

-there is not a case for dir€ct orindirect intervention. This is vervdifferent from primary control f;expenditur€ on local public goods(which may themselves be inpurs intoproviding basic righis) resting with ihecentre. Thus. decentralization of somegovemment powers need not lead toIocal elite capture abd exploitation. aswas the fear afterind€pendence. Singhand Srinivasan (2013) characterized!his possibility of improvement ingovemance as Covernance EnhancinsFederalisnr (GEF).

To sumrnarize. the newNTTIAaloghas to define irs own role carefutly,but at tire same time limit its directintervention in the Indian economy. Itcan serv€ as a foundation for rethinldngtax aulhorities for sub-narionalgo!emments, improving the eliciencyof government expenditures at alllevels,decentralizingwherepossible,and streamlining and integrating thesystem of intergovemmental transfers.This conceptual reform programwould be ambitious. but extremelvbeneficial for improving govemanciquality and increasing economicgrowth.

ReadingsBrennan. ceotfrey, and James M.

Bu.hanan (1980), The Pavet ta Tar:A altticol Foundatia s al a l:i!.alCo sIihttioh. Canbridger CanrbridSe

Breto., Albea ( 1995). Co,?e/ri,?Gavertnerts: An E.onohi. TheD^' atPolitics and Publn rdar.e. CambridgeUniversiry Pres, New York.

Breron, Albert (2000), Federalisnr anddecenfalizalion: o{neBhp righrs and rhesuperiority of federalish. Pr6ln,r; rn?Jo hlal of lle.lefttliln, Vol. 30. No. :(Spring).!p. I 16.

Careaga. Maitc, and Barry Weingasr,2001. Fiscal Fedcralism, cood Covemince.and EconoBic c.owth in Mcxico,workingpaper, Sranford UniveBity

Rao. M, Covinda. and NirvikarSinsh (2001), How ro rfiink AbotrrLocal Govemment Retbm in India rwnhM-A- R^o), in Ecokot k Rehnk dhd theLiberolndtnn aJ the lndiar Ecanoni!:Essdrs nt Ho,out of Richard T. Shtk.l.ed., K.P Kalirajan. Edward Elsar, pp.335-190

Riker, Willianr H. ( I96:1), r'?d?ral,r,r.

Singh. Nir!jkar {2008), FiscalDecentralization in China aid lhdia:

Competitive. Cooperative or Marke!PreseNirg Fcderalisn!, /,rrlr. a/r/,.eMd aqcnent. 9 (1). available at htty'l/wrN.spaetcon/article.php?id=413

Singh, Ninikar, and T.N. Srinivasan( 201.1), Federalism and EconomicDevelopnrent ir IDdiar An Assessment,in N. Hope. A. Kochar, R. No1l. T.N.S!inivasan. eds.. r.atro,,. ,{e&.- i,Inli.r: Chollekges. Ptospaos an.1Le.$o s.Ne{ Yorkr Cambridge Univetsity Press.

Tiebout. Chailes, (1956), "A PureThcory ol Local ExpendiLures, -/oartrdld' P o h i ra I E con aDr. Octobe\ 64. pp.4t 6 -

21.Wheare, Kennerh C. (1951) r.d.ra1

Gorerrr?r/. l"r edirion. London: Oxford

Wdngast, Baal,, (1991), Constirutionsas Goveman.e Slruchtres: The PoliticalFoundations ol Secure Markels. Jr,/,a/ol lhslrtt bhal dnd n,eoreticdl Econoni.s.r.19.211,61.

I This maledal d.aws on Singh andSrinivasan (2011).

2 This material draws on Sinsh andsnnivasan (2013). tr

( E.Mi I : box i er k(i6. -edn )