Equalisation Transfers Based on Spending Needs and Fiscal Capacity of State Governments in India

Abstract

This study addresses an important policy issue pertaining to the determination of equalisation transfers to Indian states. It empirically estimates the effect of transfers on the expenditures of 29 Indian states using panel data methodology. It also determines transfers based on the spending needs and fiscal capacities of states. The results indicate a strong crowding-in effect of transfers on the public spending of states and the presence of the flypaper effect. Fiscal transfers relate positively to revenue expenditures in 13 out of 18 general category states and in 8 out of 11 special category states. The estimated amounts of equalisation transfers for all 29 states in four alternative scenarios, based on alternative benchmarks of fiscal capacities and spending needs, range between ₹555 billion and ₹16,048 billion. We believe these results will help policymakers and other stakeholders to design appropriate fiscal transfer strategies such that all citizens can avail a standard level of public services in India. JEL Codes: H77, H73, H72, C23