Context

• The Central government’s alarm has been on the mounting debt burden and the deteriorating fiscal situation in some States due to diversion in fiscal prudence.
• As both the Union government and States are expected to work closely in a co-operative federal structure, frictions arising out of these exchanges might have repercussions on both resource sharing and expenditure prioritisation.

What is India’s fiscal federalism?

• Fiscal federalism refers to the financial relations between the country’s federal government system and other units of government.
• It refers to how federal, state, and local governments share funding and administrative responsibilities within our federal system.

Three issues in India’s fiscal federalism                   

• First: are a set of issues related to Goods and Services Tax (GST) such as the rate structure, inclusion and exclusion of commodities, revenue sharing from GST and associated compensation.
• Second: State-level expenditure patterns especially related to the welfare schemes of States.
• Third: the conception and the implementation of central schemes.

Meaning of fiscal prudence

• Fiscal prudence is defined as the ability of a government to sustain smooth monetary operation and long-standing fiscal condition.

Where should state government spend the borrowed money?

• Fundamental infrastructure: Ideally, governments should use borrowed money to invest in physical and social infrastructure that will generate higher growth, and thereby higher revenues in the future so that the debt pays for itself.
• Targeted expenditure only: On the other hand, if governments spend the loan money on populist giveaways that generate no additional revenue, the growing debt burden will eventually implode.

Why there is a need for Fiscal Council?

• Institutionalizing fiscal practices: With a complex polity and manifold development challenges, India need institutional mechanisms for fiscal prudence.
• Transparency: An independent fiscal council can bring about much needed transparency and accountability in fiscal processes across the federal polity.
• Fiscal prudence: International experience suggests that a fiscal council improves the quality of debate on public finance, and that, in turn, helps build public opinion favourable to fiscal discipline.

What does fiscal consolidation mean?

• Fiscal consolidation is defined as concrete policies aimed at reducing government deficits and debt accumulation.

Why fiscal consolidation is needed?

• Fiscal expansion financed through debt and the resultant debt accumulation have important impacts on the economy both in the short run as well as in the long run.

How to achieve fiscal consolidation?

• Better targeting of government subsidies and extending Direct Benefit Transfer scheme for more subsidies
• Improved tax revenue realization For this, increasing efficiency of tax administration by reducing tax avoidance, eliminating tax evasion, enhancing tax compliance etc. are to be made.
• Enhancing tax GDP ratio by widening the tax base and minimizing tax concessions and exemptions also improves tax revenues.

Suggestions

• Amend FRBM Act for complete disclosure: First, the FRBM Acts of the Centre as well as States need to be amended to enforce a more complete disclosure of the liabilities on their exchequers.
• Centre should impose conditionalities: Under the Constitution, States are required to take the Centre’s permission when they borrow. The Centre should not hesitate to impose conditionalities on wayward States when it accords such permission.
• Use of financial emergency provision: There is a provision in the Constitution of India which allows the President to declare a financial emergency in any State if s/he is satisfied that financial stability is threatened.
• Course correction by the Centre: The Centre itself has not been a beacon of virtue when it comes to fiscal responsibility and transparency. It should complete that task in order to command the moral authority to enforce good fiscal behaviour on the part of States.

Conclusion

• Fiscal correction at the State level is important. While there exists a need for raising additional resources at the sub-national levels, expenditure prioritisation has to be carried out diligently. The Centre, too, on its part needs to demonstrate commitment to fiscal discipline by sticking to announced fiscal glide path to ensure the sustainability of a frictionless cooperative federal structure.

Mains question

Q. Why Fiscal correction at the State level is important? Why fiscal consolidation is needed? Write in context frictionless cooperative fiscal federal structure.

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