The last fortnight witnessed a rare confluence of events that may have a significant impact on our economic prospects.

First, the Sixteenth Finance Commission submitted its report in the backdrop of several Southern and Western states demanding a higher share in devolution in keeping with their contribution to the nation's GDP. The report is important in three respects: a) The Commission retained the 41% share of union tax revenues to the states as fiscal devolution. In addition, the Commission proposed Rs 8 lakh crore as local body grants, with 45% allocated to urban areas. Both are salutary proposals. If we include grants, centrally sponsored schemes, and interest-free loans for capex, the union transfers to states account for 51.7% of the gross non-debt revenue, or 56.5% of total tax and non-tax revenues, excluding capital receipts, or 59.6% of gross tax revenues.

The states are spending 60% of the total public expenditure in the country, the highest share in a federal country. The union is spending only 37% of the total public expenditure, and there is a structural deficit after non-discretionary expenditure on transfers to states, wages, pensions, and interest payments. There is no fiscal room for additional resources. The real challenge of fiscal federalism is the weak third tier of local governments. The local governments only spend 3% of the total public expenditure, the lowest share among all G-20 countries! And local governments are emasculated in all states except Kerala. States need to follow fiscal discipline and devolve more resources and powers to local governments; that........

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