Economic Survey Chapter 4: Fiscal Federalism and Accountability

The chapter 4 of the Economic Survey is titled, “Reconciling Fiscal Federalism and Accountability: Is there a low equilibrium trap?”

This chapter argues that fiscal federalism and fiscal accountability is necessary for the long-run institutional development of the country.

Fiscal accountability involves two things

  • A low and declining dependence on devolved (transferred) resources by the Central Government (When the state and local Government depends less on the Central Government for resources, it means that they are raising their own resources through taxes. This leads to the taxpayers paying in a visible and direct way to the tax authorities. Therefore, they exercise more accountability.)
  • A high and rising share of direct taxes in total taxes. (The impact of direct taxes is felt more by the taxpayer. Therefore, he exercises more accountability)

The survey has examined India’s performance as per the above standards and found the following results:

  • Apart from China, India has the lowest share of direct taxes in total taxes. Its reliance on direct taxes seems to be declining. It has been intensified with the introduction of GST.
  • As compared to other countries, states in India (second tier) generate a very low share of its revenue from direct taxes ( 6 percent in India, 19 percent in Brazil and 44 percent in Germany.)
  • India’s Rural local Government’s  (third tier) reliance on own resources is just 6 %. It means that for 94 % of its resources, they depend on the central or state Government.
  • India’s Urban local Governments (third tier) are closer to international norms. Their own revenues as a share of total revenues are higher than Brazil and Germany, while their direct tax share (about 18 percent of total revenues) is only marginally lower than Brazil (19 percent) and somewhat lower than Germany (26 %).
  • This is evidence that Urban Local Governments are more fiscally empowered than Rural local Governments so far in India
  • There is a variation across states when it comes to local Governments.
  • We have established that States and Local Governments generate a low share of its revenues from direct taxes.
  • One possible explanation is that they haven’t been devolved enough powers to collect taxes.
  • However, one key finding is that these tiers (state and local Government) under-collect direct taxes even relative to the powers that they have.
  • Whether this could lead to a low equilibrium trap of weak direct tax collection leading to inadequate service delivery provision, back to weak collection and accountability, needs to be actively discussed.



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