A Study on Intergovernmental Transfers and Revenue Effort of Indian States

This article examines how intergovernmental transfers and borrowing autonomy influence the revenue effort of Indian states using panel data for 28 states from 2000 to 2019. Applying two-way fixed-effects specification and robustness estimations, the study tests whether fiscal transfers and expectation of bailouts lead to a compromise in fiscal behaviours in terms of revenue effort. The estimates show that market borrowing improves revenue effort by promoting fiscal discipline, while borrowing from the Centre weakens it, indicating the prevalence of soft-budget constraints. Transfers do not significantly reduce revenue effort once state-specific and time effects are controlled, suggesting that low fiscal effort is largely structural. This is again validated by the significant positive impact of revenue decentralisation, which consistently enhances revenue effort across all specifications, highlighting the role of fiscal autonomy. Disaggregated estimates for the general and special category states reveal stronger decentralisation effects for special category states and mild transfer disincentives for general states. The results highlight that the underlying factor behind the lower revenue effort of Indian states is institutional and structural, though borrowing autonomy and transfer dependency also have a limited impact. The findings stress that empowering states through greater fiscal autonomy, clearer accountability and limited reliance on bailouts is the key to improving sub-national revenue performance. JEL Codes: H2, H21, H3, H7