Introduction
Fiscal imbalance refers to a situation where a government’s revenue generation falls short of its expenditures. In other words, it is a mismatch between the income and spending of the government, leading to fiscal deficits and increasing public debt. Fiscal imbalance can occur at both the central and state levels, and if not addressed, it can negatively impact a country’s economic stability, inflation, investment climate, and overall development.
Understanding Fiscal Imbalance
There are two types of fiscal imbalances:
1. Vertical Fiscal Imbalance:
This occurs between different levels of government—typically between the central and state governments—due to mismatches in revenue-raising capacity and expenditure responsibilities. States often depend heavily on the central government for financial transfers.
2. Horizontal Fiscal Imbalance:
This refers to disparities in revenue generation and expenditure capacity among different states or regions. Some states are wealthier and can raise more revenue, while poorer states struggle to fund basic services.
Indicators of Fiscal Imbalance:
- High fiscal deficit (when total expenditure exceeds total revenue)
- High public debt-to-GDP ratio
- Low tax-GDP ratio
- Heavy reliance on borrowings
Causes of Fiscal Imbalance in India
- High subsidies on food, fuel, and fertilizers
- Increasing revenue expenditure (salaries, pensions, interest payments)
- Low tax compliance and a narrow tax base
- Frequent loan waivers and populist schemes
- Poor performance of public sector undertakings (PSUs)
- Inefficient tax administration and leakages
Impacts of Fiscal Imbalance
- Increases government borrowing and interest payments
- Reduces funds available for productive investments
- Can lead to inflation and macroeconomic instability
- Adversely affects credit rating and investor confidence
- May result in intergenerational debt burden
Measures to Correct Fiscal Imbalances
1. Expenditure Rationalization
- Reduce unproductive spending such as excessive subsidies.
- Implement better targeting of welfare schemes using Direct Benefit Transfer (DBT).
- Promote public-private partnerships (PPPs) for infrastructure development.
2. Increasing Tax Revenues
- Widen the tax base and improve compliance through digitization and GST reforms.
- Rationalize tax exemptions and introduce progressive taxation policies.
- Strengthen tax administration and reduce evasion.
3. Disinvestment and Asset Monetization
- Strategic disinvestment of loss-making PSUs.
- Use of asset monetization programs to generate non-tax revenues.
4. Fiscal Responsibility Legislation
- Strict adherence to the Fiscal Responsibility and Budget Management (FRBM) Act.
- Set realistic targets for fiscal deficit and debt levels.
5. Strengthening Federal Fiscal Transfers
- Better formula for devolution of taxes by Finance Commission.
- Encourage states to raise more own-tax revenue and promote fiscal discipline.
Conclusion
Fiscal imbalance, if not addressed, can hinder India’s economic growth and development. While some degree of fiscal deficit may be necessary for development and recovery, sustained imbalance can create long-term risks. A balanced approach involving expenditure control, revenue enhancement, and institutional reforms is essential to ensure fiscal sustainability. Coordination between the central and state governments is also crucial for reducing both vertical and horizontal imbalances and maintaining macroeconomic stability.