Abstract
This paper examines the relationship between federal transfers and fiscal deficits in India. The system of federal transfers has been criticized on the grounds that it distorts the incentives for states to promote fiscal discipline. We analyze the relationship between transfers, state domestic product, and fiscal deficit for a panel of states during the period 1990–2010. The paper finds a positive long-run relationship and bi-directional causality between primary/gross fiscal deficits and non-plan transfers. Further, a negative long-run relationship and one-way causality between state domestic product and transfers is observed, with causality going from state product to transfers. These results are confirmed by multi-variate cointegration analysis, which finds a long-run relationship between fiscal transfers, state product per capita and the primary deficit of the states. The evidence in the paper is consistent with the system of fiscal transfers being “gap- filling.”
Highlights
Intergovernmental fiscal transfers typically serve a number of different objectives, ranging from dealing with both vertical and horizontal fiscal imbalances to influencing regional and local economic stabilization (Boadway and Shah 2007)
The main policy challenge for the federal transfer system in India is to evaluate the economic situation of all the regions periodically and to devise mechanisms and criteria such that fiscal transfers can contribute to reducing regional gaps
We examine the complex relationships between federal fiscal transfers from the central government, both planned and non-planned, and both state fiscal deficits and state domestic product per capita
Summary
Intergovernmental fiscal transfers typically serve a number of different objectives, ranging from dealing with both vertical and horizontal fiscal imbalances to influencing regional and local economic stabilization (Boadway and Shah 2007). The main policy challenge for the federal transfer system in India is to evaluate the economic situation of all the regions periodically and to devise mechanisms and criteria such that fiscal transfers can contribute to reducing regional gaps. The resulting soft budged constraint could have the consequence of contributing to the persistence of regional inequalities, to the extent that the transfers from the central government might be used to fund non-productive expenditures at the local level. We examine the complex relationships between federal fiscal transfers from the central government, both planned and non-planned, and both state fiscal deficits and state domestic product per capita. The paper makes use of a data set on Centre–state transfers and state fiscal deficits over the period 1990–2010 It evaluates empirically whether there is evidence in the data with respect to one of the main causes for concern, i.e., the “gap-filling” nature of federal transfers.
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