Overview of Fiscal Federalism in India

In the Indian fiscal framework, states primarily handle social services and share responsibilities with the Union government for economic services. Despite this, the evaluation of their fiscal performance often focuses on deficits and debt rather than the quality of their public spending.

Quality of Public Spending

• Recent trends indicate a deterioration in public spending quality as subsidies and transfers overshadow investments in development.
• Political promises of "freebies" for electoral gains compress investments in physical and human capital.

Deficits and Debt Management

• Controlling deficits and debt is crucial for sustainable fiscal management.
• The decentralisation theorem suggests macroeconomic stabilisation and redistribution as primarily central functions.
• Article 293 (3) of the Constitution requires states indebted to the Union government to seek borrowing permission.
• The Twelfth Finance Commission recommended reducing Union intermediation, although the practice continues.
• The Union government bears responsibility for enforcing fiscal deficit limits set at 3% of the gross state domestic product (GSDP).

Challenges in Fiscal Management

States accumulate significant debt, resulting in high interest payments that crowd out productive expenditures. Despite this, states attempt to expand fiscal space due to constrained fiscal environments.

Evaluation of Spending Quality

• Assessment should focus on the quality of public services provided by states, unlike the Union government, which focuses on macroeconomic management.
• Subsidies and transfers are expanding, crowding out investments in social and physical infrastructure.

Factors in Subsidy and Transfer Decisions

• Opportunity costs of subsidies and transfers, which displace more productive expenditures.
• Possibility of more effective and cost-efficient policy interventions to achieve redistribution goals.

Misleading Expenditure Classification

• Expenditure on "development" and "non-development" categories can be misleading.
• Many "freebies" fall under social or economic services but do not contribute to long-term development.
• Essential general services like safety, security, property rights, and contract enforcement are not wasteful.

Current State of Public Spending

Education and Capital Spending

• Education expenditure by states is about 2.2% of GDP, down from 2.5% in 2011-12.
• The decline in education spending leads to a rise in inequalities as affluent classes migrate to private education, leaving the poor with substandard public education.
• States' capital outlay-to-GDP ratio remains stagnant at 1.96%, with adjustments for Union loans further lowering effective capital spending.

The proliferation of freebies has adverse effects on empowerment and could lead to social repercussions. It is essential for policy focus to shift towards sustainable, quality investments in social and physical infrastructure to foster development.