Fiscal Federalism and Decline of the Third Tier in India: A Case for Sharing of the New GST

Background/Objectives: Increasing number of development agencies and economists are emphasizing on the merits of decentralization. In this context, this study examines the state of fiscal decentralization to sub-national governments in India. It highlights the incomplete process of fiscal decentralization to the urban local bodies in India and suggests reforms for the same.

Methods/Statistical Analysis: This study measures the extent of fiscal decentralization in India using various quantitative indicators as suggested by the International Monetary Fund, such as: share of sub national government in the revenues and expenditures of higher levels of government, sub national expenditures as a % of Gross Domestic Product, sub national revenues as a % of Gross Domestic Product, and share of own revenue and devolved resources in sub national government’s total revenue.

Findings: The main findings here suggest that India is a highly decentralized nation in terms of fiscal decentralization to State Governments, however, that is not the case when it comes to the urban local governments. Urban local bodies are neither able to raise adequate revenues from their ‘own’ sources, nor are they devolved much resources by the Centre and State Governments. A review of the Indian municipal finance system reveals that Indian municipalities lie in doldrums. There is an urgent need to relook into their finance system and carry out reforms. Given the limitations faced by the third level of government in raising revenue from ‘own’ sources, this paper presents a strong case to share the new Goods and Services Tax with them.

Improvements/Applications: It is expected that the GST Council and the concerned policy makers take the reform suggested into serious consideration so that cities can also get a share in the buoyancy created by them.