Essay on Fiscal Federalism

Fiscal federalism is the study of how expenditures and the revenues are allocated across the different layers of administration. It focusses on the system of transfer payments and the grants by which the Central government shares its revenues with the lower level of the government.

India is a federal country with division of functions between the Centre and the State. The tax authority and expenditure responsibility of the two levels are assigned in terms of the Union, State and Concurrent lists. The states have a major role in the provision of social and economic services. However, the major tax powers lie are assigned to the Centre. The important central taxes being customs, excise duty, personal income tax and corporate income tax. In the states, the retail sales tax is one of the most important. The Constitution recognizes that the states’ tax collections are inadequate to meet their expenditure requirements and hence it provides a provision for transfer of taxes from the Centre to the state. There are multiple channels through which the transfer from the Central govt. can take place: through the Planning Commission, Finance Commission and Specific Ministries

Indian fiscal federalism is marked by many challenges. Firstly, there is a high level of vertical and horizontal fiscal imbalance. Secondly, the multiple transfer channels creates problems of focusing the transfer only to fiscally disadvantaged states. Also, the transfer by the have not only created serious disincentives but also result in inequity. The change in the political and economic environment have also triggered the need for a change. The emergence of a coalition government system at the Centre have also led to competitive populism leading to asymmetric arrangements. The economic liberalization and the opening up of the economy, require changes in the system to make states more proactive in providing infrastructure, social services and ensure fiscal discipline.

Switzerland has three layers of government: Communes at the local level, the Cantons