Fiscal Federalism

Abstract

Abstract This chapter highlights the basic tenets of fiscal federalism, making a distinction between the traditional focus on the link between decentralization and welfare to its more modern-day extensions. The idea of fiscal federalism is couched in the belief that multi-level governments can augment the pursuit of efficiency and equity in the provision of public and merit goods through cooperation, competition, and coordination among central and sub-national governments. India’s constitution provides for an independent body, namely the Finance Commission, for this purpose. The constitutional arrangements imply an asymmetry in the assignment of resources and responsibilities between the central and the sub-national governments. This has resulted in the centre having a larger share of resources, and the states having larger responsibilities. The system is brought in balance by a suitable scheme of transfers from the centre to the states. The challenge is to design a scheme of fiscal transfers that provides the right incentives and facilitates comparable standards of public and merit services throughout the country. In this chapter, the modern extensions of the idea of fiscal federalism are also extensively discussed. These deal mainly with five aspects, viz. fiscal competition among jurisdictions, political economy aspects of fiscal federalism, market-preserving fiscal federalism, environmental federalism, and fiscal decentralization and growth. These are all aspects of federalism that have a bearing on the evolution of fiscal federalism in India and are often reflected in the changing terms of reference of the Finance Commissions.