India's political economy challenge is to contain ‘transfer union’ discord | Mint

India's political economy challenge is to contain ‘transfer union’ discord

Article 293 (3) of the Indian Constitution ensures that the debt of constituent states of the Indian Union is kept in check by New Delhi, as states in India need the Centre’s permission to borrow.
Article 293 (3) of the Indian Constitution ensures that the debt of constituent states of the Indian Union is kept in check by New Delhi, as states in India need the Centre’s permission to borrow.

Summary

  • Perceptions have grown in the Eurozone and India that transfers from richer states are funding profligacy in poorer ones. Measures need to be taken to assuage growing resentment.

Although all federal states have some mechanisms for the transfer of resources from richer to poorer constituents, if the perception grows that the richer states are subsidizing profligacy or incentivising populist policies in the poorer states, the union could be politically destabilized. Such perceptions are gaining currency both in the Eurozone and in India.

In the Eurozone, there is rancour between the poorer southern states and the richer northern ones. The phrase ‘Transfer Union’ is often used to describe transfers of resources from the latter to the former. Although the Union of India is structurally a very different kind of federation than the Eurozone, there is nevertheless a similar perception in the southern and western states that revenues generated from their taxpayers are being transferred to northern and eastern states. They have therefore been compelled to borrow more than what is necessary for their own development.

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What does Indian data show?: The table alongside aggregates data for direct (personal and corporate) and indirect (goods and services) tax collections, their share in the common tax pool and the public debt of 21 major Indian states and Union territories. Since the states vary in size, they have been brought on the same level by showing the numbers on a per-capita basis.

The averages of states aggregated into the northern and eastern region (Uttar Pradesh, Rajasthan, Madhya Pradesh, Chhattisgarh, Bihar, Orissa, Jharkhand, West Bengal, Assam) on one hand, and the southern and western region (Maharashtra, Gujarat, Karnataka, Goa, Andhra Pradesh, Telangana, Tamil Nadu, Kerala and HDPC) on the other, are shown in the table. ‘HDPC’ is an acronym for Haryana, Delhi, Punjab and Chandigarh that comprise a high-income enclave in the otherwise poorer northern and eastern region.

The table shows, first, that the taxes raised by India’s northern and eastern states are equal to the taxes transferred to them. The southern and western states, however, raise four times the amount in taxes than what is transferred to them.

Second, the table shows that on average, there is no significant difference between the two sets of states in the debt burden as a share of gross state domestic product (GSDP). However, the per capita debt burden in the southern and western states is much higher, as their borrowing capacity is higher on account of higher per capita incomes and tax- paying ability.

Third, unlike the European Monetary Union, the Indian version of the ‘Transfer Union’ does not entail transfers from richer southern states and western States to the poorer north and east, but from the two surplus regions to the central government in Delhi that collects most of these taxes.

Fourth, in the European Monetary Union, it is the poorer states that are more highly indebted, which is what one would expect. In India, however, there is no appreciable difference in the indebtedness of the two sets of states. What lies behind this counter-intuitive difference is the nature of budget constraints in the two federations. Protocol No. 12 annexed to the Maastricht Treaty of the EU imposes an upper limit of 3% of GDP for budget deficits and 60% of GDP for gross public debt. There is, however, no effective mechanism to enforce these limits, even though the Delors Commission that formed the basis of the European Monetary Union had recommended ‘binding’ constraints on budget deficits among its constituents.

In the Indian Union, the kind of ‘binding’ or hard budget constraint envisaged by the Delors Commission is mandated in Article 293 (3) of the Indian Constitution. This ensures that the debt of constituent states of the Indian Union is kept in check by New Delhi, as states in India need the Centre’s permission to borrow. Since this constraint is strictly imposed through restraints on both budget deficits and tax/GSDP ratios (also envisaged but not enforced in the EU), there is on average no appreciable difference in the tax/GSDP ratios of the richer and poorer states.

However, on a per-capita basis, India’s richer states are more indebted because their per-capita incomes are higher. Since there are large net tax transfers from the southern and western states, it can plausibly be argued that they are effectively borrowing money to facilitate such transfers.

Of course, the Eurozone and the Union of India are structurally very different. The former is essentially only a monetary union, though greater fiscal union was originally envisaged. India is both a monetary and fiscal union. The former comprises independent nation-states that have sovereign authority, whereas sovereignty resides with New Delhi in the latter. There are, however, transfers from richer states in both cases that can create domestic geopolitical instability.

The debate over this asymmetric contribution can get geopolitically messy if the political dispensations in the Centre and states are at loggerheads and there is a feeling that the rights guaranteed to them under the Constitution are being undermined either in letter or in spirit, or the perception gains ground that they are being made to foot the bill for profligacy and poor policies in other states. Measures need to be taken to assuage growing resentment. The two unions can also perhaps learn from each other’s experience in adjusting their extant fiscal rules—too soft a budget constraint in one case and too hard in the other—to arrive at an optimal policy mix.

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