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The first full-year budget of Arun Jaitley is what the Indian Constitution is meant to be: unitary in form and federal in spirit.

The Union Budget for 2015 is arguably independent India’s first federal budget. No budget in recent memory or distant history has transferred this magnitude of financial resources to the states as this budget has done—not even in 1974-75 when the share of states in excise duty was doubled.

This, the stated position of cooperative federalism of Prime Minister Narendra Modi should pave the way for a union of states budget in the next 10 years, if not sooner.

In policy terms, the biggest reform undertaken in this budget, which is not readily evident, is that public expenditure policy has now been moved decisively and firmly to the jurisdiction of the state governments. This, along with the ongoing trend in decentralization of fiscal policy, including the taxation policy, will alter the design of fiscal federalism in India.

Overtime, the system will get into equilibrium state with revenue raising being centralized thereby availing of the efficiency gains, and the expenditure management resting with the states resulting in major gains in allocative efficiency.

With this, Jaitley has laid the foundation of the union of states budget and that ought to have been the core of his Vision 2020. Unfortunately, it has not been articulated more clearly. While the Vision 2022 statement is encouraging, some thoughts and detailing of steps would have lent it greater credibility, otherwise there is a risk of statements being made and later fading out. Had that been done, this budget would have been a visionary budget. But it is a still a game changer.

In moving towards the direction that it has, the impact of Jaitley’s budget will be felt beyond the confines of a budget; he has given the Bharatiya Janata Party (BJP) a distinct economic ideology. So far, bar the trimmings and wrapping, the economic policy of the BJP had been the same as that of the Congress.

Not only does this budget start the process of internal liberalization, as distinct from external liberalization, it also gives shape to “cooperative federalism". The agenda of changing the federal functioning has so far been only an idea and limited to the operational governance challenges faced by state governments in a federal setup. As such, it had stopped short of advocating the kind of structural changes that are required. This budget gives it precisely this dimension.

By giving states control over the public expenditure policy, the Union Budget has made the scheme relevant to the post-liberalization era. The real credit for this, though, must go to Y.V. Reddy and the 14th Finance Commission.

In the post-reform era, state governments have had to reorient to provide public services to cater to the diversified demand conditions prevailing in different regions and to regulate and monitor the functioning of the market. This has shifted the focus of governments from direct participation and distribution activities to one of enabling and regulating provision of services.

As a consequence, the expenditure role and composition of states had changed towards provisions of social expenditure.

Post reforms, there has been no decentralization of economic power from the centre to the states. If anything, there has been an increase in the degree of centralization essentially because of tax reforms, be it the value added tax (VAT) or the proposed goods and services tax (GST). The powers of the state governments have not only been constrained but actually curtailed.

In this context, the increase in states’ share of taxes will restore the larger issue of balance of fiscal/economic power. This is a big move made in the least disruptive manner. The increase in the transfer has to be seen in the context of the centralization changes made in the taxation system. It is about resources but also about economic power.

To a large extent, it may also be restricted by the fact that the BJP has traditionally been a votary of a powerful centre. So a higher degree of federalization will be seen as a weakening of the centre, though it need not be so.

Going beyond the operational irritants of centre-state relations, this shift towards the states has come at a time when there are compelling systemic reasons to restructure the federal setup in India. The net result is that the states are caught in a bind; with the centre squeezing from top and local bodies snipping away from below. The states have reacted to these developments by building entry barriers and becoming protectionist. Be it the entry tax on goods entering or passing through West Bengal, or the tax on crude oil in Uttar Pradesh, or the “export" duty on iron ore in Goa. These fiscal measures apart, even physical controls are being enforced which add up to a restrictive policy of economic protection. This trend, if left unaddressed, threatens the federal setup itself.

Finally, the next step should be to initiate steps towards resource federalism. In the market-led economy, natural resources—minerals, oil, natural gas, and hydropower—are the key revenue drivers of, and major constraints to, growth and its spread across the sub-national economies. This necessitates a framework for resource revenue sharing in addition to the “transactional revenue" sharing that is being done.

Even though all this has been promoted by the 14th Financial Commission award, it must be recognized that Jaitley has used the political space created by a stable union government to decentralize expenditure policy, thereby empowering states to manage expenditure and service delivery. The shrinking fiscal space has been used to create an expansive political space.

This is perhaps for the first time a Union finance minister has spoken of treating the states as equal partners in economic development. Earlier, they have been seen merely as implementing agencies of the centre’s wishes, not even of the vision.

Another important subtext is the need to view public finances from a national perspective and not just the perspective of the central government. The finance minister will, hopefully, take his intentions forward and address the concerns of states with respect to GST so that it can be implemented quickly in a form which is mutually acceptable and beneficial.

An important aspect of the budget is to seek to remove the market and regulatory distortions that are weighing on economic efficiency to create an environment of equitable opportunities which fosters rational inclusive growth. Some of the proposed legislation, such as the Public Contracts bill and the Infra Regulatory Reform bill, if properly framed, can help in reducing disputes and anomalies in the infrastructure space. The merger of Securities and Exchange Board of India (Sebi) and the Forward Markets Commission (FMC) can strengthen the commodity regulatory framework.

In the underlying state-centric spirit of the budget, state governments should ideally get a larger role in the regulatory framework of the country.

Assigning a greater role to the market in economic activity has necessitated diffusion of the economic power of the central government, and more active participation of sub-central governments in the regulatory system. At present most of the regulatory powers are vested with or are subservient to the Union government. This needs to change.

The budget also does well to continue the shift to a transparent natural resource allocation and pricing policy. From an objective-driven discretionary allocation to a competitive bidding-based allocation framework.

To the government’s credit, the coal blocks auctions have progressed fairly well so far and can add significantly to the finances of states. One hopes that the legislative processes that have been set in motion will continue to their logical conclusion and that retrospective changes won’t be necessitated.

The budget continues the transition to a fair market structure for hitherto subsidized goods and services, viz, food, power, fuel, fertilizers and transportation.

While the finance minister rightly spoke of plugging leakages in subsidies and targeting them to the deserving, he seemed to imply that subsidies were necessary per se and would be continued.

The adage that fortune favours the brave applies to Jaitley. He has been very lucky insofar as he has been able to counteract the fiscal squeeze caused by the Finance Commission’s award with the fiscal elbow room that has been created by structurally lower natural resource prices for a re-orientation of public expenditure policy from entitlement-based fiscal transfers to the incentivization of private, household and foreign investment. It has been clearly recognized that higher public investment is the need of the hour and to his credit, Jaitley has budgeted for an increase in public investment.

However, given that oil and other commodity prices globally are at structurally lower levels, the budget could have done much more in terms of articulating a longer-term vision for India’s natural resource security.

Haseeb Drabu is a long-time Mint contributor and columnist, an economist, and also a senior leader of the Peoples Democratic Party.

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