Intergovernmental Transfers and Fiscal Federalism in India: A Critical Assessment of the Divisible Pool and Grants-in-aid Framework

Abstract

This article undertakes a rigorous reassessment of the framework governing resource transfers from the union to subnational governments in India, interrogating its constitutional foundations, distributional adequacy and implications for development finance, with specific reference to the recommendations of the Sixteenth Finance Commission. The central contention is that the progressive hollowing out of the divisible pool, driven primarily by the union’s persistent recourse to non-shareable cesses and surcharges, has eroded the revenue entitlements of state governments that are constitutionally guaranteed. A methodological argument is advanced that prevailing assessments of transfer size, which normalise total transfers relative to gross tax revenue (GTR), systematically misrepresent the union’s actual resource availability; since FC grants as well as non-FC grants alike draw upon the Consolidated Fund of India, they are more appropriately measured as shares of gross revenue receipts. The empirical analysis reveals that the systematic drift of transfer composition towards conditionality-laden non-FC flows has progressively curtailed subnational budgetary discretion. This article further shows that the existing vertical devolution architecture is structurally inadequate for bridging the fiscal gap between the union and states and argues that the FC-16’s institutional modifications, including a conditional bargain on cesses and the termination of revenue-deficit grants, do not resolve the underlying structural deficit. These findings raise substantive questions about whether cooperative federalism can be sustained under the prevailing transfer architecture.