Fiscal federalism faces strain; Subramanian, Kapur call for reform

Jaipur: India's fiscal federalism, the system that governs how resources are shared between the Union and states, is facing challenges.At a JLF session Thursday on their book, ‘A Sixth of Humanity: Independent India's Development Odyssey', former chief economic advisor Arvind Subramanian and academic Devesh Kapur said that the country's federal unity is being strained by widening regional disparities and contentious fiscal transfers.
Subramanian emphasised that redistribution is inevitable in any federal system but cautioned that the current trajectory risks becoming politically unsustainable."Some degree of redistribution between richer and poorer states is part of nation-building," he said. However, the pattern of transfers must remain politically viable, he said, adding that if richer states feel perpetually penalised and poorer states feel perpetually dependent, the federal compact will fray.Kapur echoed this concern, stressing that India's fiscal system historically relied on central transfers to balance uneven development."Federalism and fiscal federalism are an important instrument in building the nation together. For that, of course, you require trust between the Centre and the states. That trust, we argue, is now stressed, and that can pose much more severe development challenges," said Kapur.The debate sharpened in recent years as southern states, which contribute disproportionately to national revenues, voiced frustration over allocations that favour poorer northern states.Subramanian argued that while redistribution is necessary, it must be accompanied by reforms that incentivise performance. "But even more important, the perception is that these are being made in the context of underperformance by the beneficiary states and consistent overperformance by the donor states. So, in a sense, these transfers create perverse incentives, which need to be fixed," he said.Kapur, however, cautioned that without transparency and accountability, transfers risk becoming politically divisive. "If there is mistrust between the centre and states, you begin to weaken the nation-building course."