Strategies to Strengthen Fiscal Decentralisation in India

India’s journey toward becoming a truly decentralized democracy depends significantly on the strength of its fiscal architecture. While the 73rd and 74th Constitutional Amendments laid the foundation for local self-governance three decades ago, the reality on the ground tells a different story. Panchayats and municipalities continue to struggle with limited financial autonomy, unclear roles, and over-dependence on grants from higher levels of government. Strengthening fiscal decentralization isn’t just about transferring money-it’s about reshaping the entire relationship between different tiers of government to ensure that local bodies can truly serve their communities.

Why fiscal decentralization matters for India’s development 🔗

Fiscal decentralization refers to the devolution of financial powers and responsibilities from central and state governments to local bodies. When done effectively, it brings government closer to the people, allowing for more responsive and efficient public service delivery. The principle is simple: local governments understand local needs better and can allocate resources more effectively than distant bureaucracies.

However, India’s experience reveals a troubling gap between constitutional intent and practical reality. According to a recent Reserve Bank of India report, panchayats earn only about one percent of their revenue through taxes, with the remaining 80 percent coming from the Centre and 15 percent from states. This extreme dependence on grants fundamentally undermines the autonomy that the constitutional amendments promised.

Defining clear intergovernmental relations 🔗

One of the most critical challenges in India’s federal structure is the lack of clarity in financial roles among central, state, and local governments. The Constitution provides a framework, but implementation has created overlapping responsibilities and confusion about who does what.

The problem of vertical imbalance 🔗

India faces a severe vertical fiscal imbalance where the Union commands 63 percent of national fiscal resources but bears only 38 percent of total public expenditure, while states shoulder 62 percent of expenditure with just 37 percent of resources. This mismatch creates dependency and limits the capacity of states to adequately fund local bodies.

The situation becomes even more complex at the local level. While Article 243H empowers panchayats to levy and collect taxes, the actual power to determine tax bases and rates often remains with state legislatures. This creates a situation where local bodies have responsibility without real authority-a recipe for inefficiency and frustration.

The need for institutional clarity 🔗

Strengthening intergovernmental relations requires more than just tweaking fund flows. It demands institutional reforms that clearly define the functional space of each level of government. The concept of “activity mapping”-breaking down broad functions into specific activities and assigning them to the appropriate governmental level based on principles like subsidiarity, economies of scale, and accountability-offers a promising approach.

Research from the National Institute of Public Finance and Policy suggests that successful decentralization requires clarity not just in what functions are assigned, but also in how they should be performed. When multiple agencies share responsibility for the same service without clear role delineation, accountability suffers and service delivery deteriorates.

Enhancing local autonomy through revenue powers 🔗

True fiscal decentralization requires that local bodies have meaningful powers to raise their own revenue. Currently, most Indian panchayats and municipalities function essentially as implementing agencies for centrally-designed schemes rather than as autonomous institutions of self-governance.

The taxation challenge 🔗

Local bodies in India have access to various tax handles including property tax, profession tax, and entertainment tax. However, their utilization remains extremely limited. State governments often impose restrictive conditions including ceiling rates, extensive exemptions, and cumbersome procedures that make tax collection difficult and unrewarding.

Consider the case of property tax-potentially the most productive local revenue source. Despite constitutional provisions, many local bodies use outdated valuation methods, maintain incomplete property registers, and face political resistance to enforcement. The result is that even where legal powers exist, actual collection remains minimal.

Beyond taxation: diversifying revenue streams 🔗

Enhancing local autonomy isn’t just about tax powers. Local bodies need access to diverse revenue sources including user charges for services, fees for licenses and permits, income from commercial ventures, and borrowing capabilities. Kerala and Karnataka provide interesting examples where panchayats have been given greater financial flexibility, with Kerala devolving 40 percent of plan funds directly to panchayats.

Access to credit markets represents another frontier. While larger municipalities in cities like Mumbai and Pune have successfully issued municipal bonds, most local bodies lack the institutional capacity and creditworthiness to tap capital markets. Building this capacity requires reforms in accounting systems, financial reporting, and governance structures.

The dependency syndrome 🔗

Perhaps the most insidious problem is what experts call the “dependency syndrome.” As grants from Finance Commissions have increased substantially-from Rs. 8,000 crore in the 11th Finance Commission to Rs. 2,80,733 crore in the 15th Finance Commission-the incentive for local bodies to make politically difficult decisions about taxation has diminished. Many elected representatives fear that imposing taxes will harm their popularity, especially in a context where voters have become accustomed to free services and subsidies.

Institutional reforms for transparency and accountability 🔗

Money flows are only part of the solution. Without strong institutions to ensure proper utilization and accountability, even generous transfers may not improve service delivery.

Strengthening State Finance Commissions 🔗

State Finance Commissions play a crucial constitutional role in determining how state resources should be shared with local bodies. However, their effectiveness has been limited by several factors. Many states don’t constitute SFCs regularly, and when they do, the quality of analysis is often poor due to lack of data and technical capacity.

More problematically, state governments frequently ignore SFC recommendations. Unlike the Union Finance Commission whose recommendations are generally accepted, state-level recommendations often gather dust on government shelves. This undermines the entire purpose of having an independent body assess local fiscal needs.

Reforms in fiscal transfers 🔗

The current system of fiscal transfers to local bodies suffers from multiple deficiencies. Transfers are often tied to specific schemes with rigid guidelines that leave no room for local adaptation. The proliferation of Centrally Sponsored Schemes, which increased from Rs. 5.21 lakh crore to Rs. 14.68 lakh crore between 2015-16 and 2023-24, has actually reduced local flexibility rather than enhancing it.

Reforming the transfer system requires several steps. First, consolidating multiple schemes into broader, flexible grants would give local bodies room to innovate and respond to local priorities. Second, making a larger portion of transfers unconditional and formula-based would reduce discretion and political favoritism. Third, building in performance incentives could reward local bodies that demonstrate good governance and fiscal discipline.

Transparency and citizen engagement 🔗

Technology offers new opportunities for transparency. Digital platforms for budget disclosure, online citizen feedback mechanisms, and geo-tagging of assets can make it harder to hide poor performance or misuse of funds. The Ministry of Panchayati Raj’s initiatives like e-Gram Swaraj and the SVAMITVA scheme represent steps in this direction, though implementation remains uneven across states.

Equally important is reviving institutions like Gram Sabhas-village assemblies where citizens can directly participate in planning and monitoring. When communities are genuinely engaged in deciding priorities and holding officials accountable, service delivery improves dramatically. Kerala’s experience with participatory planning demonstrates what’s possible when local democracy is taken seriously.

Learning from successful models 🔗

While challenges are formidable, examples from within India show that stronger fiscal decentralization is achievable. Kerala’s panchayats manage substantial budgets and have demonstrated capacity in planning and implementation. Karnataka’s devolution framework provides local bodies with greater autonomy in several sectors. West Bengal’s panchayats have shown how even in difficult governance environments, committed implementation can yield results.

Internationally, countries like Brazil and Indonesia have successfully navigated transitions to more decentralized systems. Their experiences suggest that success requires not just legal frameworks but sustained political commitment, capacity building, and patience to allow institutions to mature.

The way forward 🔗

Strengthening fiscal decentralization in India requires action on multiple fronts simultaneously. Clear activity mapping must define what each level of government should do. Local bodies need real taxation powers along with capacity building to use them effectively. State Finance Commissions must be professionalized and their recommendations implemented. The transfer system needs fundamental restructuring to provide flexibility while maintaining accountability.

Beyond technical reforms, the challenge is ultimately political. Strengthening local bodies means state governments must be willing to give up control. It means elected representatives at all levels must prioritize long-term institutional development over short-term political gain. And it means citizens must engage actively in local governance rather than remaining passive recipients of government largesse.

The promise of the 73rd and 74th Amendments was to create genuine local self-government in India. Three decades later, that promise remains largely unfulfilled. But with determined effort-clear institutional design, adequate resources, transparency in operations, and genuine political commitment-India can still realize the vision of development driven by empowered local communities.

What do you think? Can India achieve meaningful fiscal decentralization without fundamental political reforms that challenge entrenched power structures? What specific steps should state governments prioritize to genuinely empower local bodies?

References

1. https://www.drishtiias.com/daily-updates/daily-news-analysis/30th-anniversary-of-the-73rd-and-74th-amendments
2. https://www.drishtiias.com/daily-updates/daily-news-editorials/fiscal-devolution-in-panchayati-raj
3. https://www.drishtiias.com/daily-updates/daily-news-editorials/dynamics-of-india-s-fiscal-decentralization
4. https://www.nipfp.org.in/media/medialibrary/2013/08/Fiscal_Decentralization_to_Rural_Local_Governments_in_India.pdf
5. https://lex-localis.org/index.php/LexLocalis/article/download/801257/1825/22510