The 16th Finance Commission (FC) has eliminated revenue deficit grants (RDGs) for the first time. This is a deliberate attempt to correct distorted incentives that have allowed persistent revenue deficits to become a fiscal feature across states.
RDGs were meant to be temporary, but became effectively permanent. States with recurring revenue deficits came to expect central gap-filling, weakening …
International experience reinforces this logic. The concept of vertical fiscal imbalance captures the extent to which state and local governments are responsible for spending without having commensurate revenue-raising powers. The larger this ‘gap’, the greater the incentive to overspend, since the political costs of taxation are separated from the benefits of expenditure. High vertical fiscal imb…
In Spain, vertical fiscal imbalances accounted for nearly 40% of the surge in public debt during the late-20th c. Similar patterns have been observed in Germany, Portugal and China. Across 28 OECD countries, empirical studies show that every 10-percentage-point reduction in vertical fiscal imbalance improves overall fiscal balance by about 1% of GDP. In other words, what local governments do doesn’t stay local. It shapes the fiscal health of the entire sovereign.
