7 PM Editorial |Critique of Indian Fiscal Federalism during COVID 19| 13th June 2020

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Critique of Indian Fiscal Federalism during COVID 19

Context:

COVID 19 and its impact on the economy has put strain on finances of both states and central government. To tackle the same, the central government has relaxed borrowing limits of states from 3% to 5%. But this is based on conditionalities.Critics say such conditionalities amount to centralization without checks and balances and expose the fragility of Indian federal system. It amounts to centre using the states distress situation to force them to adopt its economic and institutional agenda

Constitution provides for ‘public order’ and ‘public health’ in the State List (Entries 1 and 6) and ‘prevention of the extension from one State to another of infectious or contagious diseases or pests affecting men, animals or plants’ as a joint responsibility in the Concurrent List (Entry 29). Hence it is the joint responsibility of both levels to tackle pandemic and need a spirit of cooperative federalism.

Increasing centralising tendencies:

Disaster Management act, 2005 empowers the central government to issue binding guidelines to states but only after consultations. But the Centre’s binding guidelines and orders as part of COVID response without consultations with states is leading to centralization tendencies.

Actions which are taken in such manner include imposition of lockdown, classification of areas into red, green, orange zones and prohibiting states to change them and conditionalities on states to raise extra debt to tackle COVID 19 crisis

Lack of coordination between centre and states is leading to avoidable hardship and misery to millions of vulnerable people. Migrant exodus is an example

Strained fiscal position of states:

Being the first responder, states need adequate fiscal resources to deal with COVID 19. But their fiscal position is strained.

Lockdown has restricted economic activities and reduced revenues of states.Even if GDP remains same as 2019-20, states are estimated to be 2.5 lakh crore short of budgeted revenues in 2020-21. In case of contraction, this loss of revenue will be higher.

In addition, pending transfers of tax devolution and GST compensation have reduced funds available to combat COVID 19. Coupled with reduced autonomy in taxation due to GST, this reduces fiscal space available with states.

In times of low international crude prices, increasing VAT on high speed diesel and motor spirit is an important avenue of revenue for states. But due to central excise levy, space to increase the tax by states has reduced. In addition, revenue through central excise levy is not shareable with states.

Faced with such fiscal constraints, states have resorted to deferment of payments to public employees and contractors. This further reduces capital investment and demand in the economy and hence growth.

States have asked for COVID 19 grants and raised borrowing limits to ensure adequate availability of funds to tackle COVID 19.

Raised borrowing limits with conditionalities:

Article 293 provides states must take consent of the centre for borrowing, when there is outstanding debt of state with centre. In addition, the centre can impose conditionalities for such increased borrowing limits. 15th finance commission is looking into what conditionalities can centre impose on states as part of its Terms of Reference.

In line with article 293, the centre has allowed increased borrowing limits from 3% to 5% of State GDP but with conditionalities. These conditionalities include:

  1. Introduction of the ‘One nation, one ration card’ scheme for all, with linking of Aadhaar with ration cards and installing point of sale (PoS) machines in all fair price shops
  2. Improvement in ease of doing business:
    1. District level assessment of ease of doing business,
    2. Automatic renewal of state industrial and commercial licences to businesses
    3. Making randomised inspections with prior notice and full transparency
  3. Implementation of power sector reforms:
    1. Reducing aggregate technical and commercial losses
    2. Direct benefit transfers(DBT) to farmers instead of charging them lower power tariffs
    3. Reducing the gap between average cost and average revenues
  4. Urban local body reforms requiring the states to notify property tax floor rates according to circle property values and to notify water and sewage charges

State can raise upto 3.5% debt without any conditionalities. But beyond that, for every 0.25% extra borrowing, one of the above conditions must be fulfilled. In addition, if 3 out of 4 conditions are fulfilled, additional 0.5% borrowing can be done.

Critique on these conditionalities on borrowing:
  1. Thrusting such conditionalities in times of distress is against spirit of cooperative federalism
  2. It sets a precedence of centre dictating to states and reducing the latter into agents of former. It leads to asymmetry of power between states and centre. Centre can then impose conditionalities irrespective of merits.
  3. States have varied circumstances and one size fits all approach will not work. Example is power sector reforms proposed. Some states like Gujarat and West Bengal are better placed than others like Andhra Pradesh, Punjab, Tamil nadu
  4. States may not opt for conditionalities which are politically difficult. DBT to farmers for power subsidy is an example. In such cases, states will forego additional borrowing. This will lead to reduced funds availability and cut of expenditure. This dampens demand and hence economic revival.
  5. Competitive federalism provides better incentives than imposition. Ease of doing business is a case of the same.
  6. Some reforms proposed are not permanent and can be reversed. Property taxes, power tariffs are examples which can be reverted back in future.

While there is a need for reforms proposed as conditionalities, effectiveness of imposition of the same is questioned. Instead, these reforms need to have been discussed with states and implemented by individual states as per their circumstances.

Need for an Institution for Bargaining and Conflict Resolution:

COVID 19 has shown the need for institutional mechanisms to enable intergovernmental bargaining, foster intergovernmental cooperation, conflict resolution, and promote non-predatory competition. Only by such cooperation, emergencies like COVID 19 can be tackled effectively.

But currently, NDC – National Development Council is no longer effective and the Inter-State Council, having been made a part of union home ministry, is not an independent institution. Hence states don’t have platforms for voicing concerns and availing remedies.

Hence there is a need for institutions like GST Council which promote cooperative federalism.

Conclusion:

Despite good intentions in initiating reforms, imposition of conditions by centre will be counterproductive. It will lead to disharmony and divisions along political lines. There is a need for independent institution which promote bargaining and conflict resolution to ensure states play their constitutional role.

Revision https://blog.forumias.com/7-pm-editorial-cooperative-federalism-during-covid-26th-may-2020/

Mains Question:
  1. Conditionalities attached to increased state borrowing limits are against the spirit of cooperative federalism. Comment? [15 marks, 250 words].
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