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Reforming India’s Fiscal Transfer System : Resolving Vertical and Horizontal Imbalances


  • C. Rangarajan


  • D. K. Srivastava


Two central problems in a fiscal transfer systemrelate to resolving vertical and horizontal imbalances. In the context of the setting of the 13th Finance Commission, this paper looks at the methodological background of fiscal transfers followed by recent Finance Commissions in India, particularly the Twelfth Finance Commission (TFC). It is noted that in India, there is long - term stability in the share of states after transfers in the combined revenues of the centre and the states. It is argued that this stability depends on linking the share of states in the transfers, particularly tax devolution with the difference in the buoyancies of central and states taxes. In the context of horizontal imbalance, it is argued that some of the recent Finance Commissions have implicitly followed an axiomatic approach to tax devolution and brought in some normative elements in determining grants. In spite of large difference in fiscal capacities, a high degree of equalization has been achieved. It is shown, for example, that in the case of TFC recommended transfers, nearly 88 percent of needed equalization was achieved while devoting 50 percent of transfers to resolving vertical imbalance. Amethodology is also developed to determine weights of vertical and equalizing components of transfers through devolution. In the case of the Twelfth Finance Commission, the horizontal component of tax devolution is strengthened by a scheme of equalizing health and education grants.

Suggested Citation

  • C. Rangarajan & D. K. Srivastava, 2008. "Reforming India’s Fiscal Transfer System : Resolving Vertical and Horizontal Imbalances," Finance Working Papers 22509, East Asian Bureau of Economic Research.
  • Handle: RePEc:eab:financ:22509

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    References listed on IDEAS

    1. Robin Boadway & Katherine Cuff & Maurice Marchand, 2003. "Equalization and the Decentralization of Revenue-Raising in a Federation," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 5(2), pages 201-228, April.
    2. Robin W. Boadway & Frank R. Flatters, 1982. "Efficiency and Equalization Payments in a Federal System of Government: A Synthesis and Extension of Recent Results," Canadian Journal of Economics, Canadian Economics Association, vol. 15(4), pages 613-633, November.
    3. repec:npf:wpaper:35 is not listed on IDEAS
    4. B. Dahlby & L. S. Wilson, 1994. "Fiscal Capacity, Tax Effort, and Optimal Equalization Grants," Canadian Journal of Economics, Canadian Economics Association, vol. 27(3), pages 657-672, August.
    5. Robin Boadway & Jean-Francois Tremblay, 2005. "A Theory of Vertical Fiscal Imbalance," Working Papers 2006-04, University of Kentucky, Institute for Federalism and Intergovernmental Relations.
    6. Ross Garnaut, 2002. "Equity and Australian Development: Lessons from the First Century," Australian Economic Review, The University of Melbourne, Melbourne Institute of Applied Economic and Social Research, vol. 35(3), pages 227-243.
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    Cited by:

    1. R. Mohan & N. Ramalingam & D. Shyjan, 2014. "Horizontal Devolution of States in India-Suggestions Before the Fourteenth Finance Commission," Working Papers id:5965, eSocialSciences.
    2. R Mohan & Shyjan D, 2010. "Tax Devolution and Grant Distribution to States in India Analysis and Roadmap for Alternatives," Working Papers id:2421, eSocialSciences.
    3. Das, Nimai, 2016. "Federal Fiscal Transfers on Health: Implications of Fourteenth Finance Commission Recommendations at Subnational Level," MPRA Paper 79627, University Library of Munich, Germany.

    More about this item


    fiscal transfer system; vertical imbalance; horizontal imbalance; Twelfth Finance Commission;

    JEL classification:

    • O23 - Economic Development, Innovation, Technological Change, and Growth - - Development Planning and Policy - - - Fiscal and Monetary Policy in Development
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General


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