Contrary to the expectations outlined above we find that in periods when a state government belongs to the same party as that at the center the state has higher than average fiscal deficits, and greater transfers are correlated with lower spending and lower deficits. The partisan effect is large, with deficits in affiliated states being 10 percent higher on average than deficits in non-affiliated states. Additional evidence indicates that among affiliated states, deficits are greater in those states where the ruling party controls a smaller proportion of seats to the national legislature, and thus states which may be politically pivotal to gain a majority in the national legislature.

We argue that this evidence is consistent with a particular model of federal politics that exists in India, consisting of electoral competition amongst different political parties where voters are responsive to local public spending and tend to vote along party lines. We find that the higher deficits of affiliated states is entirely financed by greater loans from the central government, as opposed to other forms of market debt, and interpret this as evidence that similar political considerations drive the distribution of deficits across subnational governments as they do other intergovernmental grants. This political effect on deficits is consistent with recent evidence on the political determinants of systematic channels of intergovernmental transfers to the states in India (Dasgupta, Dhillon, and Dutta 2001, Khemani 2002, and Rao and Singh 2000).

The contrast of the Indian experience versus other international evidence suggests that the effect of institutions of fiscal decentralization on subnational spending and deficits is dependent on the nature of the political incentive environment. This analysis thus provides a rationale to somewhat dissociate the problem of subnational fiscal deficits from the institutions of fiscal decentralization (such as rules of intergovernment fiscal transfers), and renew focus on general political determinants of deficits, or on institutions of _political_ decentralization. We develop a simple model where the counter-intuitive effects of political partisanship and intergovernment transfers on subnational deficits in India can exist in equilibrium under specific electoral institutions and voting behavior. The empirical evidence provided here may motivate the development of a more general theory, and subsequent crosscountry empirical testing, of the sensitivity of the impact of fiscal decentralization instruments to variation in federal political institutions around the world.

There exists a substantial macroeconomic literature on the political and institutional determinants of fiscal deficits of the national government (see Alesina and Perotti 1995, 1996 for excellent surveys and von Hagen, 1992). Some of this political and institutional analysis carries over to the case of subnational governments, with a political game played within subnational governments between different agents, in addition to any federal game. Poterba (1994) and Alt and Lowry (1994) examine the effect of divided governments on fiscal policy in the American states, and find that adjustment to fiscal shocks is slower in states with 3