Designing Transfers Policy With Normatively Determined Revenues And Expenditures Of State Governments In India




This study addresses an important policy issue of designing equalisation transfers from the union government of India to the states. It empirically measures the own revenue efficiency and potential of General Category and Special Category States using the frontier approach for panel data.  It also analyses the effect of transfers on states’ own revenue and its components. Results indicate a strong crowding-out effect of transfers in General Category States and a strong crowding-in effect in Special Category States. Amounts of additional transfers required to provide equal level of public services for all 29 States in four alternative scenarios range between ₹1072 billion and ₹15,948 billion. The range is based on alternate benchmarks of fiscal capacities and expenditure needs. We hope that these results will be useful to policymakers and other stakeholders to design appropriate fiscal transfer strategies such that all citizens can avail a standard level of public services in India.


Fiscal equalisation, expenditure needs, fiscal capacity, Indian states

Authors Bio

K Shanmugam, Madras School of Economics

Senior Research Scholar, Madras School of Economics and former Chief Secretary of Government of Tamil Nadu

K.R. Shanmugam, Madras School of Economics

Director and Professor, Madras School of Economics


Allers, M., de Haan, J., and Sterks, C. 2001. Partisan influence on the local tax burden in the Netherlands. Public Choice 106 (3–4): 351–363.

Aigner, D.J., Lovell, C.A.K., and Schmidt, P. 1977. Formulation and estimation of stochastic frontier production function models. Journal of Econometrics 6: 21-37.


Alfirman, Luky 2003. Estimating stochastic frontier tax potential: Can Indonesian local governments increase tax revenues under decentralization. CFEA Working Paper No. 03-19, University of Colorado at Boulder.

Alm, J., and Duncan, D. 2014. Estimating tax agency efficiency. Public Budgeting and Finance 34: 92–110.

Bahl, R., Martinez-Vazquez, J. and Sjoquist, D.L. 1992. Central city-suburban fiscal disparities. Public Finance Quarterly 20: 420-432.

Baretti, C., Huber, B., and Lichtblau, K. 2002. A tax-on-tax revenue: the incentive effects of equalizing transfers: evidence from Germany. International Tax and Public Finance 9: 631– 649.

Battese, E.C. and Coelli, T.J. 1992. Frontier production functions, technical efficiency and panel data: with application to paddy farmer in India. Journal of Productivity 3: 153-69.

Blair, P. 1992. Financial equalization between local and regional authorities in European countries. Local Government Studies 18: 7- 27.

Bird, Richard M., and Smart, M. 2002. Intergovernmental fiscal transfers: International lessons for developing countries. World Development 30(6): 899-912.

Boadway, R. 1980. Intergovernmental Fiscal Transfers in Canada. Toronto, Canada: Canadian Tax Foundation.

Boadway, R. 2004. The theory and practice of equalization. CESifo Economic Studies 50: 211-254.

Boadway, R and Frank Flatters. 1991. Federal-provincial relations revisited: Consequences of recent constitutional and policy developments, in McMillan: 87-121.

Boadway, R., Sandra, R. and Anwar Shah. 1993. The reform of fiscal systems in developing countries: A federalism perspective. Paper presented at the Conference on Fiscal Reform and Structural Change, New Delhi.

Boex, J. and Martinez-Vazquez, J. 2004. Designing intergovernmental equalization transfers with imperfect data: Concepts, practices, and lessons. Georgia State University Working Paper No. 04-21.

Bradford, D.F. and Oates, W.E. 1971. The analysis of revenue sharing in a new approach to collective fiscal decisions. Quarterly Journal of Economics 85: 434-48.

Buchanan, J.M. 1950. Federalism and fiscal equity. American Economic Review 40: 583-599.

Buchanan, J, M. 1952. Federal grants and resource allocation. Journal of Political Economy 60: 208-17.

Cornwell, Christopher, Schmidt, Peter and Sickles, R.C. 1990. Production frontiers with cross sectional and time series variation in efficiency levels. Journal of Econometrics 46: 185-200.

Courchene, T.J. 1978. Avenues of adjustment: The transfer system and regional disparities. In Canadian Confederation at the Crossroads: The Search for Federal-Provincial Balance. Walker, M., ed., 145-86. Vancouver: The Fraser Institute.

Cyan, M. R., Martinez-Vazquez, J., and Vulovic, Violeta. 2013. Measuring tax effort: Does the estimation approach matter and should effort be linked to expenditure goals. International Centre for Public Policy-Andrew Young School of Policy Studies Working Paper, Georgia State University, Atlanta.

Dahlberg, M., Mork, E., Rattese, J., and Agren, H. 2007. Using a discontinuous grant rule to identify the effect of grants on local taxes and spending. Journal of Public Economics 92(12): 2320–2335.

Dash, B. B., and Raja, A.V. 2009. Institutions and the quality of governance: An empirical study on interstate differences in economic development in India. Asia-Pacific Developmental Journal 16:1–26.

Farrell, M.J. (1957). The measurement of productive efficiency. Journal of Royal Statistical Society 120: 253-81.

Hansjörg, Blöchliger and Claire, Charbit. 2008. Fiscal Equalisation. OECD Economic Studies 44: 1-22.

Jha, Raghbendra. 1999. Tax efficiency in selected Indian states. Empirical Economics 24: 641-54.

Jha, Raghbendra and Sahni, Balbir S. 1997. Tax efficiency and productivity analysis: The case of Canadian fiscal federalism. Public Finance 52(2): 186-197.

Jondrow J, Lovell C.A.K., Materov, I.S and Schmidt, P. 1982. On the estimation of technical inefficiency in the stochastic frontier production model. Journal of Econometrics 19: 233-238.

Kumbhakar, S. 1990. Production frontiers and panel data and time varying technical inefficiency. Journal of Econometrics 46: 201-211.

Ladd, H. F. 1994. Measuring disparities in the fiscal condition of local governments. In Fiscal Equalization for State and Local Government Finance, Anderson, J.E. ed., pp.21-54. Praeger, Westport, CT.

Ladd, H. and Yinger, J. 1994. The case of equalization aid, National Tax Journal XLVII: 211- 224.

Ma, Y. 1997. Intergovernmental fiscal transfers in nine countries: Lessons for developing countries. World Bank Policy Research Working Paper No. WP 1822.

Maarten Allers and Ishemoi Lewis, J. 2011. Equalizing spending needs of sub-national governments in a developing country: the case of Tanzania. Environment and Planning: Government and Policy 29: 487-501.

Martinez-Vázquez, J. and Searle, B. 2007. Fiscal Equalization: Challenges in the Design of Intergovernmental Transfers. Springer Science & Business Media.

Meeusen, W. and Broeck, J.V.D. 1977. Efficiency estimation from Cobb Douglas production function with composed Error. International Economic Review 18: 435-44.

Mogues, Tewoda J., and Benin, Samuel. 2012. Do external grants to district governments discourage own revenue generation? A look at local public finance dynamics in Ghana. World Development 40(5): 1054-67.

Munoz, Andres Felipe, Gustavo Axel Radics and Claudia Bone. 2016. Sub-national fiscal disparities and intergovernmental transfers in LAC. Review of Public Economics 219 (4): 35-66.

Musgrave, Richard. (1959). Theory of Public Finance: A Study in Public Economy. New York, USA: McGraw-Hill.

Naganathan, M., and Sivagnanam, K.J. 2000. Federal transfers and tax efforts of states in India. The Indian Economic Journal 47: 101–110.

Oates, Wallace E. 1972. Fiscal Federalism. New York, USA: Harcourt Brace Jovanovich Inc,

Oates, W. 1999. An essay on fiscal federalism. Journal of Economic Literature 37 (3): 1120-1149.

Panda, P. K. 2009. Central fiscal transfers and states’ own revenue efforts in India: panel data models. Margin: The Journal of Applied Economic Research 3(3: 223-242.

Pessino, C., and Fenochietto, R. 2010. Determining countries’ tax effort. Hacienda Pu´blica Espan˜ola/Revista de Economı´a Pu´blica 195: 61–68.

Pessino, C., and Fenochietto, R. 2013. Understanding countries’ tax effort. Fiscal Affairs Department, International Monetary Fund Working Paper No. WP/13/244, Washington, DC.

Piancastelli, M. 2001. Measuring the tax effort of developed and developing countries: Cross country panel data analysis-1985/95. IPEA Working Paper No. 818.

Purohit, M. C. 2006. Tax efforts and taxable capacity of central and state governments. Economic and Political Weekly 41: 747–51.

Rangarajan, C., and Srivastava, D.K. 2004. Fiscal transfers in Australia: Review and relevance to India. Economic and Political Weekly: 3709-3722.

Ridge, M. 1992. Local government finance and equalization: the case of Ireland. Fiscal Studies 13: 54- 73.

Roa, Govinda M. 2019. Redesigning the fiscal transfers system in India. Economic & Political Weekly 31: 52-60.

Sandhya Garg, Goyal, Ashima, and Pal, Rupayan. 2016. Why tax effort falls short of tax capacity in Indian states: A stochastic frontier approach. Public Finance Review: 1-28

Saraf, Richa and Srivastava, D.K. 2009. Determining general and specific purpose transfers: An integrated approach. Madras School of Economic Working Paper No. 40, Chennai.

Sarma, J.V.M. 1991. Panel data models and measurement of states’ tax effort in India. Journal of Quantitative Economics 7(1): 145–64.

Schmidt, P. and Sickles, R.C. 1984. Production frontiers and panel data. Journal of Business and Economic Statistics 2: 367-74.

Scott, Anthony D. 1952. Federal grants and resource allocation. Journal of Political Economy 60: 534-538.

Shah, Anwar. 1988. Capitalization and the theory of local public finance: An interpretive essay. Journal of Economic Surveys 2 (3): 209-243.

Shah, Anwar. 1994. A fiscal needs approach to equalization transfers in a decentralized federation. World Bank Policy Research Working Paper No.1289.

Skidmore, M. 1999. Tax and expenditure limitations and the fiscal relationship between state and local governments. Public Choice 99(1–2): 77–102

Sole´-Olle´, A. 2006. The effects of party competition on budget outcomes: Empirical evidence from local governments in Spain. Public Choice 126(1): 145–176.

Spahn, P. 2007. Equity and efficiency aspects of interagency transfers in a multi-government framework. In Intergovernmental Fiscal Transfers: Principles and Practice, R. Boadway and A. Shah, ed., The World Bank.

Tiebout, Charles M. 1956. A pure theory of local expenditures. Journal of Political Economy 64 (5): 416-424.

Vaillancourt, Francois and Richard Bird. 2005. Expenditure-based equalization transfers. ITP Working Paper No.0512.

Vailliancourt Francois and Richard Bird. 2007. The interregional incidence of central budgets in federation: Some evidence from Canada. Public Budgeting and Finance 27(1): 1-19.

Zhuravskaya, E. V. 2000. Incentives to provide local public goods: Fiscal federalism, Russian style. Journal of Public Economics 76(3): 337–368.