State capacity & the soft budget constraint: Fiscal federalism, Indian style

In this paper, we explore the effects of India's federal structure on state-level fiscal responsibility. Drawing from a 1991–2018 dataset, we argue that higher levels of transfer and borrowing dependence (soft budget constraints) from the central government facilitate lower levels of fiscal responsibility by subnational governments. Our hypothesis is tested using panel regressions on fiscal responsibility outcomes across Indian states. We also evaluate the effects of the world's largest employment program, the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA), on subnational fiscal responsibility. We find that rural public employment measures are conducive to lower levels of fiscal responsibility. Soft budget constraints constitute a key structural feature of Indian federalism.