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Unit 24: Fiscal Federalism in India

with the lowest per capita income and consumption in the world. Over the entire period of 40 years Notes
from 1910 to 1950, the growth rate of the economy had been nearly zero. After Independence, the
government assumed the responsibility of creating conditions for the growth of economy. The
Government of India adopted a policy of ‘mixed economy’ under democratic framework, in which
the public sector had to play a leading role. The government assumed a leading role in the economy
because the economy was dominated by the primitive agricultural sector. The private industrial sector
of the country was underdeveloped and, therefore, could not be relied upon to play a significant role
in the economic development of the country for at least a decade or two. As a strategic measure, the
government adopted the Five Year Development Plans. The basic objectives of Development Plans
are (i) to achieve a target growth rate, generally 5 percent, (ii) to promote employment opportunities,
(iii) to remove poverty, and (iv) to reduce income inequalities. The basic philosophy of the
government’s overall economic policy was ‘growth with social justice’.
India’s Discretionary Fiscal Policy

The most difficult problem that the Government of India faced was how to mobilize resources for
development. It was with this background that the government formulated its fiscal policy. Under the
conditions highlighted above, the Government of India adopted discretionary fiscal policy. The
government has throughout used its discretion to determine the pattern and level of both taxation
and its expenditure. In order to raise financial resources, the government adopted very extensive
direct and indirect taxation with highly progressive tax rates. Prior to economic reforms of 1991, the
government changed its tax rate and exemption limits almost every third year, sometimes in each
annual budget. So was the case with the level and pattern of its expenditure. The dominant aspect of
the government’s discretionary fiscal policy was to raise maximum possible revenue through direct
and indirect taxation for meeting its revenue requirement, and to allocate expenditure in the manner
that could promote growth and employment. Whether the government succeeded in these objectives
with its fiscal policy is a different issue.
However, total tax revenue collected through taxation had fallen much short of government’s plan
expenditure. Therefore, the government had rely heavily on deficit financing, especially on borrowing
from the RBI. In effect, India has adopted a deficit budgeting policy.
The fiscal policy of the Central Government is reflected in its annual budget. Let us have an overview
of the annual budgets of the Government of India in recent years. The annual budget has two sides :
(i) revenue side, and (ii) expenditure side. The government revenue includes tax revenue and non-
tax revenue, and government expenditure includes both development and non-development
expenditures. Both government revenue and expenditure are further classified under : (i) revenue
account, and (ii) capital account. Let us have a glance at the pattern of government revenue and
expenditure in some detail.
Fiscal Reforms and Fiscal Deficits Since 1991

Till 1990-91, the Government of India made minor modifications in its fiscal policy (including both
taxation policy and expenditure pattern). But drastic changes were made in the fiscal policy and
fiscal management of the country in 1991. Here we present a brief analysis of the reforms made by
the government in its fiscal policy since 1991.
In 1990, India faced an unprecedented foreign exchange crisis mainly due to rise in crude oil prices
following the Gulf War. Due to a sharp rise in oil price, import bill of the country shot up from a
monthly average of $287 million in June-August 1991 to $671 million in the following 6 months. As a
result, the foreign exchange reserves declined from $3.11 billion in August 1990 to $896 million in 16
January 1991. The Indian economy was almost on the verge of economic collapse. However, financial
help provided by the IMF in the form of a loan of $665 million in September 1990 helped the country
tide over the crisis. This crisis created conditions and need for evaluating the significance and relevance
of country’s economic policies in general and fiscal policy and foreign trade policy in particular.
Fiscal reform was one of the main aspects of the economic policy reforms made in 1990-91.
In the opinion of the experts, a reversal of the fiscal expansionism was essential for restoring the
macroeconomic balance in the economy. The government adopted a policy to reduce the fiscal deficit.

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