The Assignment of Taxes and Expenditures in India*

In this paper, we review the basic theories of fiscal decentralization, apply them to the problem of tax and expenditure assignments in a federal system, and consider the Indian case in the light of economic principles. We note the centripetal bias of India’s federal fiscal arrangements, which give the center indirect power over states’ expenditure decisions, as well as creating a vertical fiscal imbalance that requires large center-state transfers. We describe some of the distortions that arise in the federal aspects of the current Indian tax system. In particular, we highlight internal trade barriers, inter-state tax exportation, and tax sharing arrangements as areas for reform. * This paper is part of a larger, ongoing study of Indian federalism. 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), and the Center for Research on Economic Development and Policy Reform at Stanford University (Fall 1998), where his stays as Visiting Fellow have provided congenial environments for the research reported here. We are also grateful for financial support from our respective institutions, ANU and UCSC. + Respective affiliations: Rao Australia South Asia Research Centre, Research School of Pacific and Asian Studies, Australian National University, and (from Dec. 22) Director, Institute for Social and Economic Change, Bangalore, India; Singh Department of Economics, University of California at Santa Cruz, and Visiting Fellow, Center for Research on Economic Development and Policy Reform, Stanford University. 2 THE ASSIGNMENT OF TAXES AND EXPENDITURES IN INDIA M. Govinda Rao and Nirvikar Singh