Indian federalism and human capital

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A decentralized approach and strong local governments can improve development outcomes

Investing in human capital through interventions in nutrition, health and education is essential for sustainable growth. But India’s human capital indicators remain weak. In the World Bank’s Human Capital Index, the country ranks 116th. The National Family Health Survey-5 for 2019-2020 shows that indicators of malnutrition have stagnated or declined in most states. The 2017 National Achievement Survey and the State of Education 2018 Annual Report show poor learning outcomes. In addition, there is little convergence between states. This is a cause for concern as these statistics could worsen due to the COVID-19 pandemic.

Several government initiatives have been launched to address these issues. The 2017 national health policy underscored the need for interventions to combat malnutrition. Based on NITI Aayog’s national nutrition strategy, Poshan Abhiyaan was launched, as part of the Integrated Child Development Program. The latest Union budget announced a “Mission Poshan 2.0” and the Samagra Shiksha Abhiyan has been the Centre’s flagship education program since 2018. However, India only spends 4% of its GDP in public spending on capital. human (about 1% and 3% respectively on health and education) – one of the lowest among its peers.

Editorial | Discouraging figures: on the 2019-2020 National Family Health Survey

International experience suggests that one of the reasons why these interventions do not lead to better results may be India’s record with decentralization. Globally, there has been a gradual shift in the allocation of expenditure and revenue to subnational governments. These trends are supported by studies showing a positive correlation between decentralization and human capital.

In recent years, India has taken steps towards decentralization. The Fourteenth Finance Committee increased the States’ share in fiscal deconcentration from 32% to 42%, which was effectively retained by the Fifteenth Finance Committee.

In India, three levels of government are envisaged, with the Constitution dividing powers between the first two levels – the Center and the States, according to the three lists in the Seventh Schedule. While public health is on the list of states, the broader subject of economic and social planning is on the competing list. In 1976, education was moved from the state list to the concurrent list through the 42nd Amendment. The placement of a subject in the competing list, in fact, indicates the presence of overriding considerations which justify the participation of the Center.

Commentary | Necessary, greater decentralization of power

On the fiscal front, while the Constitution assigns most of the spending responsibilities to the states, the Center has significant sources of revenue. To remedy this vertical imbalance, the Constitution provides for fiscal transfers through fiscal deconcentration and subsidies. In addition, the Center may award “grants for any public purpose” under article 282 of the Constitution. While fiscal transfers that are part of fiscal decentralization are unconditional, transfers under grants or centrally sponsored programs (CSS) may be conditional. Consequently, the increase in the share of States in fiscal deconcentration represents a more significant decentralization.

Several imbalances

The 73rd and 74th Amendments strengthened decentralization by constitutionally recognizing panchayats and municipalities as the third level and listing their functions in the Eleventh and Twelfth Schedules, respectively. These include education, health and sanitation, and social protection for panchayats, and public health and socio-economic development planning for municipalities. However, the Constitution leaves states to determine how they are empowered, resulting in wide disparities in the roles played by third-level governments.

Despite some moves towards greater state autonomy in many areas, the centralized nature of India’s tax architecture has persisted. Centrally sponsored programs have made up a significant portion of intergovernmental fiscal transfers over the years, accounting for nearly 23% of transfers to states in 2021-2022. But its disproportionate role deviates from the intentions of the Constitution. Article 282 of the Constitution is listed as a “Miscellaneous financial provision”, unlike articles 270 and 275, which fall under the “Distribution of income between the Union and the States”. Constitutional expert Nani Palkhivala characterized it as a residual power, believing that subsidies under Article 275 in accordance with the recommendations of the Finance Committee are the most appropriate regular route. The Supreme Court in Bhim Singh v Indian Union observed that “Article 282 is normally intended for special, temporary or ad hoc regimes”.

There are also issues in the design of CSS, the conditions being too prescriptive and generally input-based. On the other hand, international experience shows that programs with results-based conditions are more effective. Additionally, CSS typically have a cost-sharing model, thus preempting state fiscal space. This is incongruous, given that many CSS cover topics from state rosters and competing rosters, such as health and education.

A third level with functional and fiscal powers would not only be more in line with the constitutional spirit, but would also lead to better results. But ironically, states, too, have been responsible for centralization. Many states do not clearly delineate or delegate functions to panchayats and municipalities.

In addition, third-level governments do not have fiscal powers either. The collection of property taxes, a major source of revenue for third-tier governments, is very low in India (less than 0.2% of GDP, compared to 3% of GDP in some other countries). The Constitution provides for State Finance Commissions (SFCs) to make recommendations on issues such as tax devolution and third-level aid grants. However, many states did not establish or complete these commissions on time, and as a result, the Fifteenth Finance Commission did not recommend any grants after March 2024 to any state that does not comply with the constitutional provisions for SFCs.

Towards a solution

As a first step, the Center must rethink the nature of its actions. It should play a facilitating role, for example by encouraging knowledge sharing between States. For states to play a greater role in human capital interventions, they need adequate fiscal resources. To this end, states should streamline their priorities to focus on human capital development. The Center should refrain from offsetting fiscal decentralization by changing CSS cost sharing ratios and increasing processes. The unconditional character of these vertical transfers must be carried out in the mind. At the same time, the heavy dependence on CSS should be reduced, and fiscal decentralization and aid subsidies should be the main sources of vertical tax transfers. Panchayats and municipalities are to be vested with the functions listed in the Eleventh and Twelfth Schedules.

Harnessing the true potential of our multi-level federal system is the best way forward for developing human capital.

Kevin James is co-author of this article and research associate at the Center for Social and Economic Progress (CSEP), New Delhi. Anoop Singh is a Distinguished Fellow of CSEP. Kandarp Patel is Director, National Academy of Audit & Accounts, Shimla. Mr. Singh and Mr. Patel worked with the Fifteenth Finance Committee. Opinions are personal.


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