An Analysis of Explicit and Implicit Intergovernmental Transfers in India
SCID Working Paper 30d
In this paper, we provide a critical overview of central-state transfers in India. In addition to examining explicit transfers through the Finance Commission, Planning Commission and central ministries, we also analyze implicit transfers that operate through interstate tax exportation and subsidized lending to the states. We quantify equity impacts of these transfers, finding that formula-based transfers have been equalizing, helping to overcome lack of fiscal capacity in poorer states, but that implicit transfers tend to go disproportionately to richer states, canceling out much of the equity impact of explicit transfers. We also highlight some of the institutional weaknesses of the current methods of intergovernmental transfers in India. We therefore make a case for reforms that would include: channeling transfers through a single, permanent, professional agency; a rule-based system of transfers rather than expanding central discretion; a transfer system with appropriate fiscal incentives for the center and the states, and minimizing implicit transfers arising from undesirable policies such as interstate sales taxes, or badly targeted policies such as subsidized credit.