Abstract
Vertical fiscal imbalance (VFI) is defined as the share of sub-national governments’ own spending not financed through own revenues. Theoretical and empirical literatures on VFIs have identified them as an obstacle to sub-national accountability and good fiscal performance. India is a decentralized economy where a marked distinction is made between the spending and revenue responsibilities between the Centre and states. However, spending decentralization has not always complemented revenue devolution, giving rise to huge VFIs in the states. This paper attempts empirically to examine the relation between VFI and fiscal performance for Indian states. It provides stylized facts on size, financing and long-run trend of VFI for 24 major Indian states. Panel data estimation for all those states, covering the period 1995–96 to 2014–15, reveals that on an average the primary deficit of the state governments decline by 15 percentage point of Net State Domestic Product (NSDP) for each percentage point decline in VFI.
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