Decentralisation challenge in India

India is a highly decentralised country, but it is still not meeting all its objectives. Some fiscal transfers from the Centre to states have achieved horizontal equity across states, while others are tilted towards the richer states. Fiscal decentralisation is not a panacea for everything. Some programmes need to be administered by the Centre to scale up investments and mobilise additional resources. Decentralisation agenda needs to be better aligned with the urbanisation agenda and scale up infrastructure investments.

There are several channels for fiscal decentralisation. One option is for the private sector to play an active role to maximise finance for development. The other option is to devolve more policy powers to state governments. The third option is for the central government to intervene directly, when the private sector is reluctant to invest. India’s decentralisation has taken twists and turns, and is still evolving.  

Fiscal Decentralisation

Fiscal decentralisation in India is much more advanced compared to other countries, with the sub-national government responsible for more than 50 per cent of government expenditures, and exceeding the global average by a big margin. Unfortunately, salaries and interest payments constitute the largest components of sub-national expenditures. Very little goes towards the development initiatives.  

How pro-poor is India’s fiscal decentralisation? We examined horizontal equity of central transfers to states (see Ejaz Ghani et al, The Poor Half Billion). The first and the biggest channel of transfer consists of tax shares and grants decided by the Finance Commission. Dividing up these funds among the states is done by an explicit formula, which places weights on factors such as the state’s area, population, per capita income, and state’s own revenues. The second source of funding used to come from the Planning Commission, which made grants and loans, for implementing state development plans. The third source of funding is the various central government ministries, which give grants to their counterparts in the states for projects, either wholly funded by the Centre or requiring the states to share a proportion of the cost. These grants are discretionary. In addition to these explicit transfers, implicit transfers are given through the subsidies for food, fertiliser, and other programmes. Additionally, sub

sidised borrowing resources for the states are provided through government-owned financial institutions.

The largest component of the fiscal transfer comes from the tax-sharing schemes. There exists a negative relationship between fiscal transfers received per capita against the per capita state domestic product, suggesting that the poor states have been given substantially higher fiscal transfers. India’s fiscal devolution has achieved horizontal equity in the tax-sharing arrangements.

However, the same cannot be said about the other components of fiscal transfers. The state plan grants that were administered by the Planning Commission used to land in richer states, as poorer states lagged the capacity to prepare development projects plans needed to access these transfers.  Funding for discretionary schemes implemented by individual ministries is even more explicitly titled towards the richer states.

Implicit transfers, including subsidies and discretionary transfers put together, are almost as large as the explicit tax-sharing arrangements. If food subsidies are largely spent on food procurement through above-market procurement prices, then the highest levels of subsidies are given to the richer states. The second biggest source of implicit transfer, fertiliser subsidy, benefits the richer states, as they consume more fertiliser. India’s implicit transfers are not pro-poor. India’s implicit transfers, when tied to a specific good or service, is consumed more in the richer states and is not achieving horizontal equity.  

Administrative decentralisation

Like fiscal decentralisation, India’s administrative decentralisation exceeds the global average. But there is considerable variation across different services. India has devolved the execution of most education programmes to the sub-national level. Evidence does not support a consistent relationship between the degree of administrative decentralisation and human capital investments. Poorer states spend considerably less on education and health programmes.

Addressing the challenge

India is already highly decentralised. Although key fiscal transfers are pro-poor, many implicit transfers are not governed by explicit rules, and tend to be skewed toward richer states. A key challenge is to strengthen the capacity of poorer states to benefit from decentralisation programmes. Simply directing more financial resources to poor regions may not be enough. This will need to be complemented with increased accountability and performance at the local level so that resources are used more efficiently and equitably.

Decentralisation is not always a panacea, especially in countries, where the physical and human infrastructure is weak, and spatial disparities across states are on the rise. A national level and federally integrated policy intervention may be needed to make investments more productive. There are some useful lessons to be learnt from the success of the Golden Quadrilateral Highway that attempted to integrate India and connected the four corners of India — north, south, east and west. Evidence suggests that higher central government spending does not crowd out state spending. If the Centre spends more on building schools, the state spends more on hiring teachers and buying supplies. Central and state spending are positively correlated in human and physical infrastructure.

India needs to align its decentralisation programmes with the urbanisation agenda. Cities can’t function without access to fiscal resources. City governments should be given a seat at the table in the decentralisation agenda. Urbanisation agenda, and scaling investments in infrastructure, could be financed through land taxation and sector-specific programmes to promote public-private partnerships.

Land tax revenue is currently an untapped source of revenue. India’s land tax revenue collected has remained virtually unchanged over the last three decades, and is extremely low in cross-country comparisons. For a country that is experiencing one of the fastest urbanisations in the world, land revenue collected can be a big source of finance for urbanisation and infrastructure investments. 

Land markets are much more distorted than capital and labour markets in India. Land distortions create twin balance sheet problem for banks. Land taxation can play a strategic role in maintaining fiscal stability while scaling up infrastructure investments to achieve double-digit growth.

The writer is lead economist, World Bank