By Nageshwar Patnaik in Bhubaneswar, February 22, 2020: Is India under Prime Minister Narendra Modi turning out to be a case of centralized federalism, like Australia?

For the first time since 1984, the 2014 and subsequent 2019 general elections handed a majority in the Lok Sabha to a single party. The landslide victory of the Midi–led Bharatiya Janata Party (BJP) slowly but steadily is changing the dynamics of center–state relations in India despite the ruling party’s promise to put “center-state relations on an even keel”.

It was initially assumed that under Modi, relationship between Centre and states might break from that of former prime ministers, who tended to prefer keeping as much power in Delhi as possible. Modi was a three-time chief minister himself and had often spoken of the humiliation of having to go to the Planning Commission in Delhi to ask for funds.

In fact, in his first term, Modi also signed on to the 14th Finance Commission’s recommendations that gave a somewhat more equitable share of funds to the states, and he spoke of “cooperative federalism”.

However, of later the state-center relations have become more centralized under Modi though this process of centralization has not been uniform across the three identified dimensions. Centralization is strongest in the political domain, but weakest in fiscal matters, where the Modi government had no option but to accept the recommendations of the 14th Finance Commission and by longstanding intergovernmental discussions on overhauling India’s complex indirect taxation system with a polity-wide Goods and Services Tax (GST), the management of which relies on center–state consent.

The strongest example of unilateral decision-making in policy terms was the shock decision of demonetization which resulted into the forced withdrawal of 500 and 1,000 rupee notes as legal tender as of November 8, 2016 and their replacement with new 1,000 and 2000 rupee notes. This decision immediately depressed the economy, depleted the revenues of the state governments and, in the process, violated both the spirit of democracy and that of cooperative federalism, Modi often talked about.

Similarly, from the scrapping of Article 370, which involved downgrading Jammu & Kashmir from a state to a Union Territory ruled by Delhi, to Central cesses that collect money from citizens without a share for the states to delaying Goods and Services Tax payments due to the state governments, Modi’s record on federalism has been at odds with the oratory he used before 2014.

It is needless to say that the GST is an extremely centralizing taxation approach and the states willingly gave up their own powers of taxation after the Centre pleaded with them that building a common market with a single tax would make everyone richer. To woo them further, the Centre also said it would compensate states for five years.

But a badly designed GST and the government’s economic mismanagement has meant that the Indian economy is languishing, with the Centre falling behind on compensation payments. Many states are now staring at a huge shortfall in their finances if compensation is withdrawn after 2022. They have now asked the Finance Commission to recommend that this compensatory mechanism be extended for three to five years or more.

Still worse is the impact of Union Budget on state finances. State expenditure as a share of Gross Domestic Product (GDP) is about 17%, while the Union government’s share of expenditure is around 13.2% of GDP (2019-20 estimates). State governments largely depend on New Delhi for revenue receipts. Between 2015 and 2020, 47% of state’s revenue receipts came from central transfers. But the central transfers to states will come down drastically due to inevitable shortfall in tax devolution, amounting to 0.75% of GDP to states when compared with the interim budget and a consequent overall fall of 0.5% GDP of total central transfers to states from 2018-19.

The anticipated shortfalls in revenue receipts will be largely due to cuts in corporate taxes, which inevitably impact state finances given their dependence on central tax transfers. Consequently, the states will find it tough to spend on development schemes due to lower than projected GST compensation making effective and transparent budget management near impossible. The states are still uncertain over nearly half their total revenue receipts as the full extent of expenditure compression is only revealed post release of funds from New Delhi to states.

By now it is crystal clear that the Union government is facing worst ever fiscal crisis, which inevitably pushing states towards a crisis too. There is no doubt that some states are infamous for poor fiscal math and bad budget management. But with Fiscal Responsibility and Budget Management Act in place, things have improved somewhat in recent years. But with growing uncertainties in central transfers, these gains may not last long.

Adding to the woes of the states, the center has delayed releasing the money for most flagship schemes like moving only 32% to Ayushman Bharat, PM-Kisan (57%), Samagra Shiksha (58%), Jal Jeevan Mission (51%) and the Poshan Abhiyan (31%), according to an analysis by the Centre for Policy Research’s Accountability Initiative by November last year. Total scheme transfers would inevitably see sharp drop in the revised schemes.

The 14th Finance Commission report details a new “trust based” paradigm of Center–state relations by recommending a shift from tied transfers (schemes and grants) to untied transfer (devolution of tax share)-based support; ending the plan-non-plan dichotomy; recommending a redesign of the Inter-State Council to cover state financial allocations that supplement the statutory transfers recommended by the Finance Commission among others.

The BJP made a commitment to “co-operative” federalism in its 2014 election manifesto. The manifesto contained a pledge to put “Centre-State relations on an even keel through the process of consultation” in which “national development” would be “driven by the states.” But promises till now remain unfulfilled. Will Modi rise to the occasion?

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