In recent years, studying fiscal federalism issues has become the preserve of reformists advocating austerity and consolidation. Not so for Dr YV Reddy. He is a development economist at heart, with long years of service in central and state ministries and the Reserve Bank of India. He has been grappling with fiscal federalism issues for years. In his lectures and articles, one discerns a running stream of ideas honed over the years. The book under review is a milestone in his research career.
In a lecture delivered at Vidhi Centre in September, 2015 (‘Fiscal Federalism in India: Some Reflections’), he surveyed the broad historical developments and said, “…we in India can be legitimately proud of our federation that simultaneously strengthened governance capabilities in states, contributed to national integration, and enabled robust fiscal federalism…” Even as the authors narrate the historical evolution of fiscal federalism and take note of other support institutions, their primary focus is on the role played by the Finance Commission (FC). Indeed, the FC has been the linchpin of our fiscal federal architecture. An early chapter deals with the evolution of fiscal federalism since the British days. There is a chapter on all the FCs, and another which recounts their approaches. The next one captures “continuity and changes” in the FC’s working.
The authors appreciate the role of the FCs in promoting fiscal federalism. They are justified in holding this view, as it is based on a close examination of all their reports, 14 in all. The FCs are seen to have held a steady course between the centre and the states though, of late, there are attempts to tilt the balance towards the centre. Some FCs resisted and some others went beyond their remit to maintain fiscal prudence. As the authors affirm, “Finance Commissions have, over time, generally demonstrated that they were truly national, equally fair to the Union and the states, apolitical and innovative, as needed.” This is because, as the authors say, “the approaches of successive Finance Commissions have remained unchanged in several ways, even as there is flexibility in introducing elements of change as warranted by circumstances.”
This continuity in approach was also observed in the manner they recommended vertical allocations. Truly, they did make allowances for structural changes in the economy and the changing roles of the states and the centre. However, as the authors aver, there was no arbitrariness or ambiguity in their recommendations. Likewise, their record on horizontal transfers was fair.
Another important factor that catalysed the functioning of the FCs was the emerging support structure, such as the Planning Commission (PC), National Development Council, etc. The PC’s role was crucial in deciding capital transfers. The authors regret that in future, they would be hamstrung in this role as the Niti Aayog, successor to the PC, has no role in capital allocations. As they explain, there is a vacuum in institutional and procedural arrangements for interaction between the Union and States. “That vacuum has been unfortunately occupied by the Ministries in the Union Government.”
The FCs could retain their reputation and trust over the years. Looking back, those were also the years when we witnessed political instability with the emergence of coalition politics. Despite such political hiccups, there was continuing cooperation between the states and the Union. This was mainly due to the deft handling of centre-state issues by the FCs and the fact that the FCs were chaired by eminent public persons, who were assisted by professional members.
Though the authors hold a rosy view of the history of fiscal federalism, they take note of recent trends suggesting that it is at a crossroads. There are references to these trends in many pages. The last chapter (‘Afterword — The Way Forward’) and the chapter on the 15th FC draw attention to them in a muted way. In recent public engagements and press briefings, Dr. YV Reddy has been openly critical of these trends and comes out as a strong defender of state autonomy.
The trends include the role of the GST Council, the Terms of Reference for the Fifteenth FC, and the new emphasis on fiscal responsibility and budget management. It is evident that the ToR runs contrary to the approach to fiscal federalism as enshrined in our Constitution. There is overreach to diminish the role of the states and to foist a “one nation, one policy” model in disregard of regional autonomy and diversity. These trends would erode the trust between the centre and states and strike at the root of fiscal federal harmony.
This book is a testament of faith in India’s commitment to fiscal federalism since Independence. It is written by two eminent economists with long experience in handling those issues. They have voiced their concerns over its future and highlight the threats it faces.
K Subramanian is a retired finance ministry official writing on financial issues