Second, there is significant horizontal inequality among states, reflecting differences in their ability to generate revenue and deliver public services at efficient costs. This inequality is exacerbated by a third problem: states with low social indicators tend to have higher vacancies, less trained administration, and higher workloads. Some states successfully implement social programs at minimal cost, while others struggle. The Indian government has tried to address these problems through centrally sponsored grants, but the complexity disadvantages states with lower capacity and encourages the process of focusing on outputs rather than outcomes. This situation leads to sparse resource allocation and limited impact on improving conditions.
On the contrary, the loans granted to States have had significant effects. For example, they have reduced the differences in the quality of infrastructure between States. The effectiveness of debt stems from the changes it brings: higher levels of debt impose both political and fiscal commitments on States and induce them to use resources more responsibly.
To improve the effectiveness of this financial instrument, the Finance Commission can set loan amounts and interest rates based on improvements in each State’s social indicators, thus encouraging a positive cascade effect. By linking financial assistance directly to social improvements, the Commission would encourage States to prioritise effective governance and targeted development initiatives. This approach not only ensures responsible use of resources, but also promotes a sustainable and equitable growth trajectory in all regions.
First, the incentive of debt would force states to address horizontal inequities by improving their revenue collection capabilities and optimizing the efficiency of social service delivery. Failure to do so could result in states facing high interest rates on loans or abandoning debt altogether, creating a costly policy dilemma for the government.
Second, the loans, rather than centrally funded grants, would give states the autonomy to use the funds to improve social indicators through locally tailored solutions. This approach provides administrative flexibility and allows states to design and implement programs without the bureaucratic constraints associated with grant applications.
Third, the fiscal burden on the Union government would be reduced significantly. Over time, the additional benefits of improved revenue streams and social outcomes would make states less dependent on large borrowings from the Union government to meet their financial needs.
Finally, effective spending on social indicators will not only strengthen government capacity to deliver services critical to redistribution but will also help accelerate economic growth and make it inclusive for all. Better social indicators will also lead to more investment in the home state, which in turn will lead to more jobs and less migration to India’s already overcrowded cities.
Viksit Bharat can only be achieved by making every state prosperous and ensuring that all citizens enjoy the benefits and positive aspects of a high quality of life. To truly implement cooperative federalism, we need to link financial assistance to concrete social outcomes and ensure that every loan leads to meaningful progress in the lives of citizens in all states.
