Fiscal federalism: Why public finance matters to every citizen

Few subjects are as central to the functioning of government—or as likely to make the average citizen’s eyes glaze over—as how governments collect and spend money. But public finance shapes nearly every interaction Indian citizens have with the state.

How much tax revenue will my state receive from the Centre? Will my local government have the resources to invest in the amenities I value? And how can I distinguish between an expensive freebie and a purposeful, targeted cash transfer?

A new book, Fiscal Fables: A Citizen’s Guide to Public Finance, demystifies India’s public finances for a lay audience and explains public finance concepts using relatable stories and examples. The book is co-written by Sarthak Pradhan and Pranay Kotasthane, two public policy researchers at the Takshashila Institution, Bengaluru.

They spoke about their new book on last week’s episode of Grand Tamasha, a weekly podcast on Indian politics and policy coproduced by HT and the Carnegie Endowment for International Peace.

Pradhan, a fellow at Takshashila, said citizens require a better understanding of public finance because when the government spends on different kinds of things, as citizens, one cannot “exit a government’s fiscal choices.” And while “every politician would like to spend more, it has consequences, both for you and future generations, and in some cases these consequences are irreversible. If we understand public finances better, we can deal with these things better.”

Kotasthane, deputy director at Takshashila, argued that the Indian tax system resembles Michael Scott, the bumbling office manager from the popular American television series The Office. Scott “was trying to be so many things at the same time. He wanted his branch to be profitable, and he wanted to be everyone’s best friend, the funniest guy in the room, inspirational, and often he ends up achieving none of those goals,” Kotasthane recounted. “The Indian tax system is identical in that sense. Anyone who has filled their income tax return knows what we are talking about. Income tax returns are so complicated…because the government is trying to achieve many things with this one instrument called tax policy.”

Tax policy is sometimes “used to promote exports, sometimes to incentivise savings, sometimes to drive infrastructure investment, sometimes to ensure balanced regional development, sometimes to boost employment,” Kotasthane said. By trying to achieve so many objectives with one instrument, the government risks losing sight of its ultimate goal, which is to raise the maximum revenue with minimum economic distortion, the scholar explained.

While the Goods and Services Tax (GST) has been criticised for its rollout, Pradhan argued the new system nonetheless represented an improvement over the status quo. By merging 11 Union and state indirect taxes, it reduced the cascading effect of taxation through the input tax credit mechanism, he explained. Pradhan also highlighted the GST Council as an institutional innovation because it brings the Union government and the state governments together under one roof, an arrangement he described as unique in India. “Can the system be better? Are there absurdities in the current GST system? Yes, there are absurdities. But is it worse than before? We don’t agree with that,” he said.

On fiscal federalism, Kotasthane argued that the media often characterises debates over the distribution of resources as a fight between Tamil Nadu and Uttar Pradesh, or Maharashtra and Bihar. But, in reality, “the fight is not so much about horizontal devolution. The real challenge is vertical devolution, that is, how much money the Union government is keeping and how much the state governments are getting.”