Guest Column | Financial centralisation a threat to India’s federal structure

One of the most alarming consequences of financial centralisation is the increasing dependence of states on the central government for their financial needs. This dependence is quite conspicuous even in sectors crucial for disaster management. Recent tragedies in Himachal Pradesh, Uttarakhand, and Tamil Nadu underscore this vulnerability, exacerbated by the states’ liquidity crunch.

India’s diverse geography, demographics, and economic landscapes necessitate a robust federal structure that allows states the flexibility to tailor policies and programmes to meet the unique needs of their population. At the core of such a structure lies the bedrock of financial and functional autonomy for states, to enable effective implementation of development initiatives and delivery of essential services with full contextual relevance. However, the growing phenomenon of financial centralisation poses a significant threat to India’s federal structure.

One of the most alarming consequences of financial centralisation is the increasing dependence of states on the central government for their financial needs.

One of the most alarming consequences of financial centralisation is the increasing dependence of states on the central government for their financial needs. This dependence is quite conspicuous even in sectors crucial for disaster management. Despite specific recommendations from the National Finance Commission regarding the devolution of funds for disaster relief, states often find themselves struggling to meet immediate needs in the aftermath of unforeseen events.

Recent tragedies in Himachal Pradesh, Uttarakhand, and Tamil Nadu underscore this vulnerability, exacerbated by the states’ liquidity crunch. The immediate spending power of the states is constrained by pre-committed liabilities and complex tax structures, such as the Goods and Services Tax (GST). Some experts attribute this fiscal strain to the states’ spending on unsustainable schemes and programmes, such as free electricity.

Initially hailed as a transformative reform, GST promised to streamline administration and increase state revenues. However, despite certain improvements, the initial optimism soon waned as states grappled with delayed remittances, inadequate compensation, and the realisation that the 14% guaranteed compensation fell far short of expectations in many states. The centralised administration of GST with limited scope for states to make decisions tilted the scales in favour of the central government.

The devolution of central taxes and plan development allocations, though seemingly transparent, involves intricate calculations and a significant degree of dependence on the Centre. This dependence compromises the states’ autonomy, exposes it to political pressures and results in erosion of federal principles.

The GST Council, designed for shared decision-making and responsibility with the participation of all states, has faced criticism for prioritising central policies and overlooking state-specific concerns, further undermining the spirit of federalism and creating a sense of alienation among state governments.

Financial centralisation, exacerbated through GST, deepens existing regional imbalances. Revenue sources like cess and fees are excluded from the divisible pool, depriving states of their rightful share and hindering equitable development. The powers of the states to impose such levies have been withdrawn after the promulgation of the GST. This inequity is particularly pronounced in states like Punjab, where reliance on indirect taxes clashes with the inflexibility of levying taxes on goods imported from other states, disproportionately impacting states and fueling economic disparities. Agricultural produce and income are exempt from payment of taxes.

Financial centralisation also opens the door to potential political manipulation. Centralised control over resources can be exploited to distort resource allocation and influence political outcomes. This creates an environment where the central government wields undue influence over state finances, compromising their autonomy and jeopardising the democratic process. The centralised structure can also marginalise smaller states and parties, silencing their voices and potentially leading to majoritarian authoritarianism that undermines the principles of federalism and pluralism. Audit and other instruments of economic intelligence and financial scrutiny also impact the central devolution of funds to the states.

The challenges posed by financial centralisation demand urgent attention, and comprehensive reforms are necessary to safeguard federalism in India. The proposed solutions encompass a range of measures aimed at restoring balance and empowering states. These include:

Destination-based taxation: This approach would empower states to retain taxes on goods and services collected within their borders, giving them greater financial autonomy and flexibility to tailor policies to their contextual needs.

Reviewing the GST Council: Ensuring effective representation of diverse state interests can foster inclusivity and address state-specific concerns.

Expanding the divisible pool: Including revenues from non-VAT sources, fees, and cess, most of which have been abolished or subsumed in central levies after the promulgation of the GST, in the divisible pool can create a more equitable distribution of resources.

Decentralising tax administration: Giving states greater control over their revenue streams can enhance their responsiveness and autonomy.

Strengthening inter-governmental fiscal transfers: This can ensure equitable resource allocation across states, promoting balanced development.

These reforms can help strengthen the country’s federal structure, empower its diverse states, and foster a more inclusive and prosperous nation. It is not just an economic imperative but also a crucial step towards protecting the democratic values and vibrant tapestry that define India. The shadow of centralisation should not engulf the federal fabric. The path of empowerment and inclusivity can truly unite India, where every state has the power to weave its unique thread into the nation’s grand narrative toward a more resilient, decentralised, and inclusive federalism. The next year’s Union Budget can perhaps be the first major financial instrument to make an effective beginning in this direction.

sureshkumarnangia@gmail.com

The writer is a retired Punjab-cadre IAS officer. Views expressed are personal.