Intergovernmental Transfers and Fiscal Equalization in India: Trends, Challenges, and Reform Options

This paper examines the evolution, structure, and effectiveness of intergovernmental transfers and fiscal equalization mechanisms in India within a comparative federal framework. Drawing on a comprehensive analytical report prepared for the Sixteenth Finance Commission, the study evaluates the extent to which India’s fiscal transfer system has addressed both vertical fiscal imbalances between the union and states and horizontal disparities across states. It analyzes long-term trends in revenue assignment, expenditure responsibilities, and the design of Finance Commission transfers, while assessing their equalization impact using descriptive and econometric evidence covering the Tenth to Fifteenth Finance Commissions. The findings suggest that while India’s system has historically played a significant equalizing role - particularly during the Eleventh Finance Commission - its effectiveness has moderated over time due to evolving policy priorities, fiscal constraints, and institutional changes. Vertical imbalances remain substantial, with states continuing to account for a larger share of public expenditure relative to their revenue-raising capacity. Horizontal equalization has been achieved to varying degrees, with distribution formulas balancing equity, need, and efficiency, though often without a clearly defined equalization objective. The paper situates India’s experience within international practices in countries such as Australia, Canada, Brazil, South Africa, and selected European systems. It highlights key lessons on the importance of defining equalization objectives, improving data systems, and adopting more transparent and norm-based approaches to measuring fiscal gaps. The analysis concludes with policy options for reform, including the potential transition toward a fiscal gap-based equalization system, improved incentive structures for revenue mobilization, and greater clarity in the design of intergovernmental transfer mechanisms.