The effects of central-government transfers to states in India

Abstract

India has witnessed an impressive growth performance since the market-based reforms were introduced in 1991. However, its regional spread has been uneven. Considering the fact that over 63% of the population lives in economically lagging states and they have over 67% of children in the age group 0-14 demographic dividends can only be realised when a system of intergovernmental transfers is designed to offset their fiscal shortfalls. The present paper analyses the design and implementation of general and specific purpose transfers in India. The general purpose transfers are given to enable the states to provide comparable levels of services at comparable tax rates. However, given the large differences in the revenue-raising capacities of the states with the richest large states having five times the per capita income of the lowest, it is politically infeasible to offset the differences in revenue-raising capacities completely. Therefore, the specific purpose grants which are meant to ensure minimum standards of meritorious services with strong externalities are extremely important. However, the analysis shows that there are too many specific purpose transfers, they are poorly targeted and inclusion of multiple objectives in each of the specific purpose transfers makes the compliance by the states difficult. Inclusive development requires a reform of the transfer system.