"States either raise their own revenue through taxes or receive money from central transfers as the state’s share of central taxes and grants. Data shows that the states do a much better job of estimating their own revenues as opposed to the transfers they receive from the Centre. The mean overestimation of the grants component (11.02%) is more than double the mean overestimation of state’s own revenues (4.47%). Grants are also much more volatile as measured by the standard deviation, which is 24.67% compared to the states’ own revenues at 7.9%. There are multiple reasons why marksmanship is especially poor for grants.
First, the grant-making process involves multiple institutions, which leads to problems such as poor computations and misaligned incentives. States project their revenue gap and basis that the Finance Commission recommends grants. Revenue gap estimation is a supremely complex task given the number of budget heads and sub-components under various departments and schemes. This naturally leads to errors. Additionally, there is also a problem of incentives. Given the importance of the revenue gap in grant allocations by the Finance Commission, states undertake fiscal dentistry—tinkering with the numbers so as to garner maximum revenues, moving numbers away from their true estimates."
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