The Political Economy of Center-State Fiscal Transfers in India*

India’s federal system is distinguished by tax and expenditure assignments that result in large vertical fiscal imbalances, and consequent transfers from the central government to the state governments. Several channels are used for these transfers: the Finance Commission, the Planning Commission, and central government ministries. The transfers include statutory tax sharing as well as various categorical and block grants. While predetermined formulas are used for some transfers, there is considerable discretion in allocating other classes of transfers. In this paper, we use panel data on center-state transfers to examine two broad classes of hypotheses: (i) the economic importance of the states, measured by the state domestic product, influences the level and the composition of per capita transfers to the states; (ii) the political importance of the states, measured by their importance in the ruling coalition, and by whether the ruling party at the central and state levels is the same, influences the level and the composition of per capita transfers to the states. We control for variables such as population and per capita income in the panel regressions, and for state fixed effects, although population can also be considered a measure of political importance. We do find evidence supporting the bargaining view of federalism, as manifested in the result that states with indications of greater bargaining power seem to receive larger per capita transfers. * This is a substantially revised version of a paper presented at the Columbia University-World Bank Conference on Institutional Elements of Tax Design and Reform, February 18-19, 2000, at Columbia University. It also forms part of a larger, ongoing study of Indian federalism by the two authors. The first version of these ideas was presented at the National Institute for Public Finance and Policy (NIPFP), New Delhi in September 1998. We are indebted to Bhaskar Dutta, John McLaren, Dilip Mookherjee, Rohini Pande, Ratna Sahay, and Barry Weingast, for detailed comments and suggestions on the February draft that led to (what we hope is) the improvement in this revision. Michael Dooley, Assaf Razin, Carlos Vegh, and Donald Wittman made useful suggestions when this work was presented at the UCSC SCCIE Development and International Economics Workshop, May 26, 2000. They are all definitely blameless for the remaining shortcomings. The second author would like to gratefully acknowledge the hospitality and support of the Research School of Pacific and Asian Studies at the Australian National University (Summer 1997), the NIPFP (September 1998) and the Center for Research on Economic Development and Policy Reform at Stanford University (Fall 1998 and Fall 1999), where his stays as Visiting Fellow have provided congenial environments for some of the research reported here. We are also grateful for financial support from ANU and the UCSC Academic Senate. + Respective affiliations: Rao Director, Institute for Social and Economic Change, Bangalore, India; Singh Professor of Economics, University of California at Santa Cruz, Santa Cruz, CA 95064. Contact information: Nirvikar Singh, Ph: (831) 459-4093, Fax: (831) 459-5900, email: boxjenk@cats.ucsc. edu