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Narendra Modi’s suggestions to change India’s federal system are not good enough. Photo: Rituparna Banerjee/Mint
Narendra Modi

’s suggestions to change India’s federal system are not good enough. Photo: Rituparna Banerjee/Mint

Modifying federalism

To be meaningful, changes in Indian federalism have to go beyond mere consultation with states

Narendra Modi’s agenda to effect changes in India’s federal system sounds good. But the suggested changes are not good enough. His agenda is limited to the operational governance challenges faced by states in a federal setup. As such, it stops short of advocating the necessary structural changes required. Obviously, his views on this matter have been formed by his decade long stint as a chief minister and that too from the leading opposition party.

To a certain extent, it may also be restricted by the fact that the Bharatiya Janata Party (BJP) has traditionally been a votary of a powerful centre. So a greater depth of federalism will be seen as a weakening of the centre, though it need not be so.

Going beyond the operational irritants of centre-state relations, there are compelling systemic reasons to restructure the federal setup in India.

First, the existing framework of centre-state relations was conceived, designed and operated in the pre-liberalization era. The underlying logic of governance was control and it was this mindset that determined centre-state relations.

Second, economic reforms changed not only the macroeconomic policy framework, by assigning a greater role to the market, they also redefined the role, quality and instrumentalities of government intervention at all levels.

In the new situation, 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. Third, the 73rd and 74th constitutional amendments added a third layer to the federal system. There has been delegation of functions and finances from state governments to the local bodies. For instance, substantial expenditure powers have been given to the local bodies. Even some revenue powers, such as those of property tax and motor vehicle tax have been passed on to the panchayats and local bodies.

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

The net result is that the states are caught in a pincer and a bind—with Union government squeezing from top and local bodies snipping from below.

It is these structural changes that have resulted in disempowerment and disenfranchisement of the states in the realm of economic policy.

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 so-called export duty on iron ore in Goa.

These fiscal measures apart, even physical controls are being enforced. All this adds up to a restrictive policy of economic protection. This trend if left unaddressed, threatens the federal set up.

The cooperative federal system that had been envisaged has become competitive federalism in a negative sense and even coercive. In such a situation, the type of consultative federalism being advocated by Modi will not be sufficient to reform the system.

Parallel to the economic and financial centralization is the trend of political decentralization—the emergence of regional parties across the country leading to a coalition rather than single party rule at the centre.

The need for a systemic solution arises from the fact that under such a situation, the logic of a federation undergoes a change. As such, what should the design of the new federal framework be?

First, federal relations must be designed for an open economy that is being driven by the private rather than the public sector.

Economic liberalization has caused huge regional imbalances across states. But state governments have no instruments to redress these imbalances.

The constitutional assignment of powers to states has to be meaningful such that the sanctity of state taxes is maintained. All lucrative and revenue yielding taxes are with the Union government; all poor country cousin taxes are given to the states.

The second aspect of redesigning the fiscal federal setup is to give states a role in the regulatory framework of the country. Assigning a greater role to the market in economic activity has necessitated diffusion of economic power of the Union government and more active participation of state and local governments in the regulatory system. At present most of the regulatory powers are vest with or are subservient to the Union government.

Third, fiscal federalism must now be linked to 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 requires a framework for resource revenue-sharing in addition to the transactional revenue-sharing that is being done.

Haseeb A. Drabu is an economist, and writes on monetary and macroeconomic matters from the perspective of policy and practice.

To read Haseeb A. Drabu’s earlier columns, go to www.livemint.com/methodandmanner-

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