Fiscal Federalism, Social Expenditure and Equity - India’s Approach

Social expenditure in India, inclusive of the food subsidy, has risen modestly over the last ten years to cross the 30 per cent mark in its share of total public expenditure, aggregated over all levels of government (8.3 per cent of GDP).  The constitution assigns responsibility for social functions largely to subnational states, but states’ share in social expenditure has actually fallen to 74 per cent, from 79 per cent ten years previously. Large national (Central Government) schemes for education, health, and the rural employment guarantee, have been motivated in part by impatience with social outcomes, but have resulted in blurring of responsibility.  Some Central schemes are partially delegated to local government, but the fiscal role and accountability of local government need to be systematized so that ordinary people can have a greater say in the configuration of social expenditure. 

Social expenditure, under the Indian constitution, is functionally assigned largely to subnational state governments, who in turn are required after the constitutional amendments of 1993 to devolve responsibility over time to the third tier of local government. A few functions like education are listed in the constitution as concurrent functions, to be shared between the national (Central) government and states. 

Public expenditure in India is classified into two major categories, non-developmental and developmental. Although core components of social expenditure like education and health are within the developmental expenditure head titled ‘Social and Community Services’, there are other pieces that have to be added on for a fuller measure.  (All data are sourced from Indian Public Finance Statistics, an annual publication of the Ministry of Finance.  The latest issue, dated August 2009, carries budget estimates for 2008-09, pre-final estimates for 2007-08, and finalized accounts for all preceding years. Expenditure on scientific research was deducted from the total for Social and Community Services.)  Expenditure on rural development, principally on rural employment generation schemes, is one such piece. There are also four heads listed by convention in the ‘non-developmental’ category, which belong in social expenditure. These are calamity relief, social security and welfare, transfers to the third tier of local government (for delivery of local public goods), and perhaps most controversially, the food subsidy. Budgeted expenditure for social expenditure so defined, consolidated across all levels of government for the latest year (2008-09), and aggregated across current and capital accounts, was around 8.3 percent of GDP.  The provision in absolute terms amounted to 11 rupees per capita per day, 72 cents in PPP current dollar equivalent. This is total departmental expenditure under the various heads, and therefore includes salaries of public officials in the relevant departments, but excludes pensions for retired personnel. 

The share of social expenditure so obtained in aggregate expenditure across all levels of government has risen slightly over the ten years, 1999-2009 (Figure 1), and crossed the 30 per cent mark in 2008-09.  At state level, the share of social expenditure was nearly 40 percent in 2008-09, reflecting their higher constitutional responsibility in this sphere.

Figure 1 

The most important need of the hour is to improve outcomes from present expenditures. This imperative has led to somewhat two contrarian trends. On the one hand, there is recognition of the need to decentralize expenditure downwards, for better alignment with spatially varying priorities and preferences.  Accordingly, there has been a steady but slow rise in the statutory shares of states in the tax revenues of the central government. Finance Commissions are appointed every five years to re-set these shares. Statutory transfers are (largely) unconditional, with those components prescribing sectoral directions amounting at most to one-fifth of the total provision. There are also other transfers to states which are non-statutory, and scheme-specific, such as for development of backward regions.   The total impact of these can be assessed by the share of state governments in aggregate expenditure, which has indeed risen over the period 1999-2009 to around 59 per cent (Figure 2). 

Figure 2 

The second trend has been that the Centre has assumed increasing responsibility for large social expenditure schemes for rural employment (the National Rural Employment Guarantee of 2005), school education, and health. These programmes are designed by the Central Government and executed through deconcentrated agencies at field level, with co-funding at the margin by states in prescribed percentages. The result has been that the share of states in social expenditure has actually declined (Figure 2), by about 5 percentage points over 1999-2009, to 74 per cent. The corresponding rise in the share of the Centre was motivated in part by impatience with poor social sector outcomes, but in the process it has resulted in blurring of responsibility, and implicitly questions the premise that social expenditures should be shaped to local preferences. 

Local preferences in social expenditures are best accommodated at the level of local government, but there is no systematic recording of expenditure at this level. It should be recalled that aggregate social expenditure as measured here included transfers to local government. These are fully transfers from states, and incorporate the rising statutory flow prescribed by Finance Commissions from the Centre for local government, which are routed through states as required under the Constitution. In 2008-09, these amounted to 1.32 per cent of aggregate expenditure across all categories, and 4.16 per cent of aggregate social expenditure. 

But that is only the unconditional flow to local government. There are also function-specific transfers from states to local government, which vary widely across states (but are not very large in any case).  A more substantial flow is from expenditure under some Central schemes, such as the National Rural Employment Guarantee, where a minimum of 50 per cent must be devolved to rural local government, with a fair degree of discretionary latitude.

The difficulty is that there is a data vacuum on receipts and expenditures of local government.  This is addressed by the Thirteenth Finance Commission which, in its report for the horizon 2010-2015 tabled in Parliament in February 2010, substantially enhanced the statutory transfers from the Centre to local government, subject to conditionalities designed to improve fiscal reporting of flows to local government, and accounting and audit at local level. By the end of the next quinquennium, these institutional improvements should enable a better picture of the extent to which social expenditure is devolved to the third tier.

The Commission also attempted, for the very first time, to incentivise improved social outcomes by pegging one of the absolute grants for the states to improvements during the grant horizon 2010-15 in the infant mortality rate (IMR). These kinds of forward incentives were not possible earlier because of lack of reliable real-time data on critical social indicators.

Another recommendation of the Commission is that the second round of fiscal responsibility legislation at the Centre, starting in 2010-11, will be fully effective only if expenditure commitments are made several years into the future, rather than merely annually, as at present.  This applies with considerable force to Central transfers to states, which are predictable only in respect of the statutory component.  The jaggedness in states’ shares in both social and aggregate expenditure (Figure above) is because of the non-statutory element in transfers to states from the Centre, which are subordinated in both total volume, and in allocation to particular schemes, to variations from year to year at the budgetary discretion of the Centre. (Rajaraman, 2008, demonstrates that the year to year changes in the composition of aggregate flows to states respond with a two-year lag to political fractionalization in the Indian federation.)  Uncertainty about receivables has been a factor in under-provision of social expenditures by states, which call for expenditure commitments on delivery personnel (teachers, health workers) several years into the future.

With the current fiscal pressure, resulting in part from the fiscal stimulus sanctioned after the global crash of 2008, there is heightened awareness of the need to improve outcomes so that social expenditure effectively translates into better social equity.

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