Essay: India’s System of Intergovernmental Fiscal Relations



India has shown remarkable resilience as the world's largest democracy, evidenced recently by the successful conclusion of its 15th general election, and the resulting peaceful transition of power from one ruling coalition to another.

Despite several challenges over the last sixty three years, India's institutions have functioned reasonable order, and supporting some degree of economic development. While economic reforms have received considerable attention over the last decade and more, India's governance institutions have also begun to attract renewed scrutiny.

In particular, one can argue that economic liberalization and market-oriented reform are only part of the reform agenda for countries like India. While reducing the role of government in certain economic activities can promote efficiency and growth, it is also critical that the government do better in areas where it has a key role, such as improving infrastructure and, even more importantly, basic human capabilities in areas such as health, nutrition and education.

One can argue that inefficient delivery of government services has been a major reason for relative failure on the latter front, and that inadequacies in the workings of India's federal system have, in turn, been important causes of inefficiency.

All this motivates continued attention to India's system of federal governance, and intergovernmental fiscal relations (IGFR) in particular. This part provides an overview of some of the historical factors behind India's system of IGFR, as well as its structural features and working in practice. It identifies some of the most important institutional developments and policy imperatives that face India's system of IGFR. It concludes with a summary of lessons and challenges for this system.

Origins and context

The origin of many of India's federal institutions can be found in its history as a British colony. At the same time, the circumstances of independence, with its traumatic partition of the country, also played a major role in shaping the structure and working of the country's intergovernmental relations.

Different ideological positions and economic circumstances have affected overall federal institutions, which are briefly reviewed in this section.

Historical development

In the nineteenth century, the British gradually took over a subcontinent that had long since become politically fragmented and strife ridden. Creeping extension of British rule crystallized with the Government of India Act, 1858, which imposed direct sovereignty under the British Crown, with an ad hoc mixture of centralized and decentralized administrative structures.

Centralization was reflected in the power of the London-based Secretary of State for India, governing through the Viceroy, an Executive Council, and a small number of district level British administrators, who exercised all sovereign powers, with no separation of legislative, executive and judicial functions.

Decentralization was exemplified by the relationship of Indian princely states to the British administration, which retained considerable internal sovereignty.

As Crown rule was consolidated in the second half of the nineteenth century, the British attempted decentralization based on administrative considerations municipal governments was introduced in the 1860s. In some cases, sub-national units ("presidencies") were split with administrative convenience in mind.

As a national political movement grew, the British developed their fiscal structures, motivated by interplay of administrative and political considerations. In 1858, the provincial governments depended completely on annual central allocations, since the center had authority over all revenue receipts and expenditures.

In 1870, some financial decentralization was begun as a prelude to meeting the perceived need for some local self-government. Initially, some expenditure categories (e.g., police, health, education) were assigned to the provincial governments, which received annual lump-sum grants, and had to have separate budgets.

Subsequently, further expenditure assignments were devolved to the provinces, along with some revenue authority and arrangements for revenue sharing.

After World War I, the British dealt with the rise of sub-nationalism and nationalism in a series of political and administrative responses, which included federal ideas to varying degrees.

The 1918 Montagu-Chelmsford Report on constitutional reforms articulated a vision of India as a decentralized federation. The Government of India Act of 1919, based on the report, devolved some authority to the provinces, and nominally restricted the powers of the central government over matters assigned to the provinces.

While the Indian government remained essentially unitary, there was some relaxation of central control over provinces by separating the subjects of administration and sources of revenue into central and provincial jurisdictions. Provinces received unambiguous control over sources of revenue such as land, irrigation and judicial stamps.

The initial assignment of revenue authority proposed would have required provincial contributions to fund the central government, but this scheme was quickly modified towards greater central fiscal autonomy, including the sharing of central income taxes with the provinces.

The Indian Statutory Commission of 1928, headed by Lord Simon, also included a review of India's financial arrangements. Sharing of the income tax between the center and the provinces was an important part of the new fiscal proposals. Various innovations in taxation were also proposed.

Subsequently, several committees met to consider the new bases for revenue sharing, particularly the formulas for distributing income tax proceeds between the center and the various provinces. The beginning of the 1930s was marked by three conferences involving Indian leaders, on the future status of India's governance.

These conferences and the British government's own deliberations, led to the 1935 Government of India Act, which proposed relatively loose federal structures that would build alliances and support their rule. The 1935 Act provided for the distribution of legislative jurisdictions with the three-fold division of powers into Federal, Provincial and Concurrent Lists.

The legislature, however, did not have the features of a sovereign legislature, as its powers were subject to several limitations.

The Act also enabled the establishment of Federal Court to adjudicate the disputes between units of the federation and was also the Appellate Court to decide on constitutional questions.

On the fiscal front, the Act provided an assignment of tax authorities and a scheme of revenue sharing that, in many respects, laid the foundations of fiscal federalism in independent India.

The Second World War and the intensification of the Indian freedom movement overtook the implementation of the federal provisions of the 1935 Government of India Act. Partition along with independence became more and more likely in this period.

Nevertheless, the framers of the Indian Constitution, beginning in the Constituent Assembly in 1946, relied heavily on the 1935 Act for the new constitutional framework. However, the effect of the planned partition of the country strengthened the vision of a strong Center.

The more decentralized aspects of the federal structure of the 1935 Act were rejected after the chaos of partition. Two key individuals supported the more centralized vision for India: Jawaharlal Nehru, who became India's first Prime Minister, and B.R. Ambedkar. Considerations of peacekeeping, coordination and a socialist economic vision all pushed Nehru toward centralization.

Ambedkar, the Chairman of the Drafting Committee for the Constitution, had a strong preference for a unitary form of government. His conception of federalism was shaped accordingly: a division of powers between center and states, but with residuary powers at the center, and central ability to impinge severely on the states in special circumstances.

Thus, the Indian Constitution incorporated centralizing features that were not in earlier British legislation, though closer to British practice in India. Centralizing features included provisions for altering states or their boundaries, central supersession of state legislatures, and explicit restrictions on state powers.

However, the Constitution did allow for states with elected governments and fiscal authority. This basic fact has permitted Indian federalism to exist and continue. While the political structures envisaged in the Government of India 1935 Act were largely abandoned in the Constitution, the details of assignments of expenditure and revenue authorities, as well as of revenue sharing and grants were preserved.

Article 246 provides for a three-fold distribution of power, detailed in separate lists in the seventh schedule. These enumerate the specific exclusive powers of the center and the states, and those powers that are concurrently held. The three lists are long and close to exhaustive, though residuary powers are explicitly assigned to the Center.

Many centralizing constitutional provisions, governing the relative authorities of the center and the states, have not been exercised because other methods have sufficed.

In particular, the center has been less concerned about explicit transfer of powers from the states to itself, or temporary suspension of state powers under constitutional provisions, because it has been able to exercise political control more directly through Article 356 of the Constitution.

This allows the Governor of a state to advise the President that the government of the state was unable to carry on "in accordance with the provisions of this Constitution", and allows the President to assume "to himself all or any of the functions of the Government of the State". In practice, President's rule means rule by the Prime Minister and the ruling party at the center, and has provided a direct means to exercise central political control, bypassing the electoral will of the people as expressed at the state level.

Another centralizing provision is Article 249, which empowers the upper house of parliament to transfer legislative jurisdiction from the states to the center. While the conditions for doing so are necessity or expediency in the national interest, the transfer requires only a two-thirds majority of members present and voting.

In any case, Article 250 allows the central legislature to make laws with respect to matters in the state list. Furthermore, Article 353 (b) authorizes Parliament to make laws on matters not explicitly in the Union list.

Finally, Article 354 empowers the President to order the suspension of the provisions of Articles 268 to 279 relating to transfers of revenues from the center to the states during a proclaimed emergency. However, all these centralizing features have not been availed of anywhere near to the extent that they might have been in 50 years of the Constitution's existence.