As compared to countries like Australia or Canada, where the ratio of the highest per capita Gross State Product (GSP) to lowest per capita GSP among states is only around 1.5 and 1.9 respectively, the ratio for India is as high as 9.
In order to deal with this problem, the Constitution and the Indian government have made several arrangements, including fiscal transfers to different states according to the needs perceived by the government.
In India, The Finance Commission is the body that has been constitutionally assigned the task of determining transfers in the form of tax devolution under global tax sharing and grants.
The Finance Commission transfers are supplemented by the Planning Commission grants and other discretionary grants determined by the central government. The approach pursued by the finance Commission in deciding transfers is normative only to a limited extent.
Equalization transfers aim at providing citizens of every state a comparable standard of services provided their revenue effort is also comparable. In other words, equalization transfers neutralize deficiency in fiscal capacity but not in revenue effort.
The horizontal dimension of transfers given by TFC asserts that if in per capita terms, all states were similar in fiscal capacities and cost conditions, the equalization criterion would be met by equal per capita transfers. But in practice, it is seen that one-third of the deficiency in revenue effort of the states is also covered by the transfers.
This paper examines central transfers to states in India by applying the Australian fiscal transfer system of revenue and expenditure equalization. It also takes in to account the effect of disabilities in the expenditure assessment.
Disabilities can be categorized into two broad types; structural, exogenous and policy-induced disabilities.
Results of the study show the following:
since the paper concerns itself more with the horizontal distribution of transfers rather than the vertical, transfers have been adjusted so that the total transfers obtained from the model remains equal to those in other methods
the expenditure side equalization has been carried out for two services with limited mobility, education and health
the paper has exhibited that the transfers suggested by the panel model are more progressive than the TFC recommended transfers