An IMF working paper says greater fiscal decentralization is usually associated with a stronger fiscal balance but can lead to more pro-cyclical fiscal policy
It is unfortunate that the budgets of state governments receive far less attention as compared to the excitement over the annual financial statement of the central government. And this is despite the fact that the states now collectively spend more than the centre does.
One big worry this year is the deterioration in state budgets. It is worth asking some tough questions about fiscal decentralization in this age of cooperative federalism. A new working paper by economists at the International Monetary Fund provides two very important insights on this issue. First, greater fiscal decentralization is usually associated with a stronger fiscal balance. That is good. Second, fiscal decentralization can lead to more pro-cyclical fiscal policy. That is bad. The authors of the report quite rightly point out: “The design and pace of fiscal decentralization need to be tailored to the specificities of the economy.”
A lot depends on budget management capability at the local level. It is no secret that India needs more of this capability in its second and third tiers of government.