Essay: Expenditure and Tax Assignments of the Government of India

The Indian Constitution, in its Seventh Schedule, assigns the powers and functions of the center and the states. The schedule specifies the exclusive powers of the Center in the Union list; exclusive powers of the states in the State list; and those falling under the joint jurisdiction are placed in the Concurrent list.

All residuary powers are assigned to the Center. The nature of the assignment of expenditure functions is fairly typical of federal nations, and broadly fits with economists’ theoretical rationale.

Economic theories of government are based on the idea that public (non-rival and non-exclusive) goods are not well provided by the market mechanism. In addition, if governments are not perfectly informed and intrinsically required to maintain macroeconomic stability, international trade and relations, and those having implications for more than one state.

The major subjects assigned to the states comprise public order, public health, agriculture, irrigation, land rights, fisheries and industries and minor minerals. The States also assume a significant role for subjects in the Concurrent List, such as education and transportation, social security and social insurance.

The assignment of tax powers in India is based on a principle of separation, i.e., tax categories are exclusively assigned either to the Center or to the States. Most broad-based (in principle though not in practice) taxes have been assigned to the Center, including taxes on income and wealth from non- agricultural sources, corporation tax, taxes on production (excluding those on alcoholic liquors) and customs duty.

A long list of taxes is assigned to the states. However, only the tax on the sale and purchase of goods has been significant for state revenues. This narrow effective tax base is largely a result of political economy factors that have eroded or prevented the use of taxes on agricultural land or incomes by state governments.

The center has also been assigned all residual powers, so that taxes not mentioned in any of the lists automatically fall into its domain.

The tax assignment system has some problematic features. The separation of income tax powers between the center and states based on whether the source of income is agriculture or non-agriculture has opened up avenues for both avoidance and evasion of the personal income tax.

Second, even though in a legal sense taxes on production (central manufacturing excises) and sale (state sales taxes) are separate, they tax the same base, causing overlapping and leaving less tax room to the latter. Finally, the states are allowed to levy taxes on the sale and purchase of goods (entry 54 in the State list) but not services.

This, besides providing avenues for tax evasion and avoidance, had also posed problems in designing and implementing a comprehensive value added tax (VAT).

The realized outcome of the Indian assignments of tax and expenditure authority, their particular history of implementation, and the response of different levels of government and tax payers to the assignment has been a substantial vertical fiscal imbalance. In 2002-2003, the states on average raised about 38 percent of government revenues, but incurred about 58 percent of expenditures. Transfers from the Center made up the balance – though perverse fiscal incentives for the states in this system have, in fact, increased the imbalance.

In fact, the ability of the states to finance their current expenditures from their own sources of revenue has seen a long-run decline, from 69 percent in 1955-1956 to 52 percent in 2002-2003.

In terms of total expenditure (including capital spending), the states were even more dependent on the center, with only 42 percent of their overall spending being covered by their own revenue receipts in 2000-01.