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4. ENVIRONMENTAL FEDERALISM AND INDIA

This Chapter consists of four parts. In the first part, theory of environmental

policy and federalism is discussed covering the use and relative efficacy of various

economic instruments (EIs). The second part specifically, deals with the usage of

economic instruments in the context of legal, institutional, and cultural considerations

prevailing in different societies. Salient aspects of designing environmental policy in a

federal set up are critically analyzed in the third part of the Chapter. The last part deals

with the environmental federalism, broad status of environmental resources in the

country, steps taken so far, and the need for further intergovernmental fiscal transfers

considering ecological aspects in addition to current socio-economic concerns, and

throws some light on the overall working of environmental federalism in India.

4.1 THEORY OF ENVIRONMENTAL POLICY AND FEDERALISM

In the absence of externalities, markets are considered an effective way of

allocating resources in the economy. In such a system, individuals compare private

benefits and private costs alone, and tend to ignore “external costs” such as pollution,

by their actions. However, in presence of externalities, when property rights are ill

defined, or when the impediments to contracts are high, markets fail to provide

efficient solutions to resource allocation. In order to correct market failures for

environmental externalities, economists have suggested two broad classes of

economic instruments (EIs):

• First, a Pigouvian tax, equal to the sum of external marginal damages

of pollution is imposed on the polluter that provides correct incentive

to individuals internalizing the pollution externality.

• Second, a “cap and trade” on pollution, where trade or offsets are

allowed in such a way that the total amount of pollution does not

exceed the cap and the price of the pollution as determined by the

markets, is equal to the marginal cost of abatement across polluters.

The application of these two instruments inter alia, requires that

pollution should be measurable.

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The conventional regulatory measure known as “command and control”

imposed by prescribing use of a particular measure or pollution abatement technology

for a given sector are also widely used in various countries. There is now vast

literature that compares the command and control regulations with the first two EIs

and testifies the effectiveness of the later. However, the literature generally assumes a

single government that makes and implements the environment policy. By and large

the literature also tends to neglect important distinctions between the geographic

distribution of different pollutants, the enforcement and fiscal authority of various

levels of government, and the interactions among these factors. Alm and Benzahf

(2009) cite specific situations for handling environmental externalities at different

levels of government:

1. Externalities generated in a particular local or sub-national area get confined

to that area; or may spill over to other jurisdictions.

2. Local governments may be better informed about how best to regulate or

enforce pollution control within their jurisdictions, but they may ignore the

effects of their actions on other jurisdictions.

3. The locally-generated emissions affect the appropriate assignment of both

expenditure and tax responsibilities among different levels of government.

4. The Pigouvian corrective tax (or other economic instruments) may be chosen

by the local government in different ways, making decisions alone either by

ignoring the actions of other agents; or by recognizing strategic responses of

other local governments.

This discussion reveals that standard treatment of environmental issues at the

aggregate level does not always consider the full implications of decentralization in

the design of environmental policy. In presence of external effects such as pollution,

private benefits and costs indeed, diverge from social benefits and costs. When the

production or use of a product also generates harmful emissions in particular, there

will be external or spillover costs from such activities. In simple economic terms,

there will be marginal external costs (MEC) from production of the good, so that

marginal social cost (MSC), defined as the sum of private and external costs, will

exceed marginal private cost (MPC) by the amount of the MEC. Because a

competitive market will produce where marginal private benefit (MPB) = (MPC)

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marginal private cost, the presence of pollution now implies that MPB (assumed equal

to marginal social benefit, MSB) equals MPC, leading to a situation where MSB <

MSC. A competitive market will, therefore, no longer achieve Pareto efficiency,

producing both too much of the product that generates the pollution and does so in a

way that is too “dirty”.

Let us now carry forward the analysis in a way relevant to subsequent

discussion on the determination of exact level of the government for discharging

various environmental functions (centralized vs. decentralized) in a federal setup.

Suppose that the utility of a (representative) consumer depends upon his or her

consumption both of a private good and of the level of pollution. Pollution is

generated by emissions, or waste discharges, that result from the production of the

private good, and production of the private good depends positively upon the use of

traditional inputs (e.g., capital and labor), and on the level of pollution and the

quantity of emissions. Emissions are, therefore, treated as an additional factor of

production like capital and labor, in such a manner that production of the private good

can be increased by the use of more capital or labor but also by discharging more

wastes as such discharges do not require the use of other inputs.

In this framework, it is straightforward to demonstrate that a competitive

market will generate a level of emissions where the marginal private benefits of

emissions are driven to zero, because emissions are effectively a “free” input whose

use does not require the payment of any factor payments comparable to, say, wages

paid for labor or interest paid for capital. Accordingly, the market outcome will lead

to an inefficiently large amount of emissions, because private firms that generate the

emissions will not consider the external costs of emissions on consumers (who are

hurt by more pollution) or on other firms (whose production is negatively affected by

more pollution). Cornes and Sandler (1986), Hahn (1989), Newberry (1990), and

Cropper and Oates (1992) had made useful contributions on this subject.

Despite limitations of market mechanism, there are several corrective policies

that a government can pursue (Sterner, 2003). The simplest of them all is a so-called

Pigouvian tax, equal to the marginal external costs of the pollution at the efficient

level of output (Baumol, 1972; Barthold, 1994; Bovernbert and de Mooij, 1994;

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Bovenberg and Goulder, 1996, 2002). The imposition of such a tax brings private

costs in line with social costs and thereby achieving the efficient level of production

of the good. Polluters who have the lowest cost of abatement will reduce pollution the

most, and polluters who have the highest cost will do less abatement. In addition to

such static efficiency, Pigouvian taxes have the dynamic property of creating an

incentive (a reduction in tax payments) for entrepreneurs to develop more efficient

ways to reduce pollution. Although they are simple in theory, implementing such

taxes in practice (where polluters cannot be identified or if taxes can be avoided by

say, “midnight dumping”) raises challenges related to the measurement of the

marginal external costs and monitoring of the pollution levels subjected to taxation.

Closely related to the tax on pollution, another policy instrument in vogue is a

subsidy on pollution abatement or on the acts of cleanup. In such a regime, firms face

the same marginal incentive as a tax, but the incentive is in the form of a “carrot”

(e.g., a subsidy) rather than a “stick” (e.g., a tax). This has the advantage of making

the instrument politically palatable, but it also has the disadvantage of encouraging

more activity in a dirty industry, which becomes counterproductive. As a corollary,

payments for ex post cleanup can be thought of as a subsidy; for example, municipal

solid waste collection occurs because government alone (in addition to nominal user

charges) provides a payment to someone to do it. Unlike a tax on waste emissions,

such cleanup activities do not reduce the amount of waste generation.

An alternative EI is a cap-and-trade system, in which a limit is set on the total

quantity of pollution allowed. This aggregate cap is then allocated to individual

polluters through a permit process, and may be auctioned or distributed without any

additional charges. The holders of the pollution permits in turn trade them to another

entity for a mutually agreed / market price. Although seemingly different on the face

of it, such a system is infact, similar to a tax. Just as under in a Pigouvian regime they

must pay the tax for each unit of pollution, in the cap-and-trade system polluters must

purchase a permit (or must forego the opportunity of selling one). As an illustration, if

a cap allowing pollution level Q leads to permits trading at a price P, then a tax set at

P should lead to a level of pollution Q. However, in view of economic uncertainties

they are not reciprocal. Insofar as a properly implemented cap-and-trade system is

concerned, it always guarantees the level of pollution (Q) but not the cost (P); whereas

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the tax system guarantees that the marginal cost of cleaning up pollution will be P but

can not guarantee that the level of pollution will be Q.

The EIs all work through economic incentives or disincentives. In addition,

there are also another set of corrective policies, including ordinary regulation,

frequently called “command and control” (CAC). Depending on the nature of the

regulation, CAC policies are often, the easiest to administer. For this reason, they are

by far, the most common approach at least initially, followed by Governments across

to control pollution. However, they do not have the same level of efficiency as other

market based EIs (Bergstrom, 1976; Hahn, 1990; Hazilla and Kropp, 1990). As a case

in point, CACs typically impose a one-size-fits-all mandate on all polluters, making

them especially, burdensome when there is a great deal of variation in the costs for

different polluters to clean up. CACs also typically, do not provide incentives for

polluters to find better ways to reduce pollution.

As stated by Cointreau and Hornig (2003), EIs could further be sub-classified

into three categories: revenue-generating instruments for governments (e.g., charges,

taxes, reductions in subsidies, or auctioned permits); revenue providing instruments,

or those that allow producers and service providers to receive income from

governments (e.g., fiscal incentives, development rights, or charge/tax reductions);

and non-revenue instruments, such as deposit-refund schemes and grandfathered

permits. All three types of instruments are put to use albit to different degrees in

modern day world.

4.2 ECONOMIC INSTRUMENTS IN CONTEXT OF LEGAL, INSTITUTIONAL AND CULTURAL CONSIDERATIONS

Use of various EIs is sensitive to prevalent legal, institutional and cultural

considerations in a society. The standard analysis of EIs for pollution control is an

elegant application of economic theory, and it provides powerful insights into the

advantages of EIs over traditional command-and-control instruments. However, like

all basic models, it carries certain explicit and implicit assumptions that must be

carefully identified and evaluated before actual implementation especially, in a

decentralized fiscal system. Adopting an instrument that is cost-effective under a

particular circumstance, may be quite ineffective in the changed circumstances.

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Accordingly, there are five key requirements enumerated in the literature for EI

mechanisms to be effective:

• First, participants (i.e., individuals or firms whose polluting behavior

is to be controlled) must be familiar with market prices / costs

implications or, in the context of tradable permits, with market

mechanisms. This is probably, easier in case of firms. Similarly,

households in some cultures are accustomed to bartering and

haggling, and may be less familiar with a posted price. Even if they

are familiar with posted prices, their behavior in say, water use is

guided more by tradition or habit, rather than by constant re-

optimization. Under such a social milieu, they may not be responsive

to taxes or fees set even at politically acceptable levels. The standard

theory tries to accommodate this point by simply describing it as a

case of an extremely inelastic demand.

• Second, key requirement is to address the concern of decision makers

believing in the maximization of profits especially, in case of private

enterprises. Even in highly evolved economies, profit remains one

important, if not the sole motive for most of the transactions. Another

complication arises in the form of so called “principle-agent

dilemma” when actual decision makers do not have the interests of

the firm’s owners. A plant manager, as an example, cares more about

making his work-day run smoothly rather than maximizing the profits

for unknown shareholders. In some other cultural contexts, managers

may have an administrative mindset to focus more on meeting output

goals rather than profit goals. Added to these are “moral hazards”

when counterproductive actions are taken by agents in response to

incentives created by government policies. For example, even if

managers are keenly watching the bottom line, they may also be

shrewdly aware of the fact that costs incurred from paying pollution

taxes or fees, or from purchasing pollution permits, can be recovered

from governments or from parent companies. Such perverse

incentives may lead to framing of “soft budgets” (Kornai, 1979) in

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the form of subsidies, lowered taxes, or more favorably administered

prices. By the same token, subsidized pollution abatement may trigger

reductions in these side-payments. Parry (2005) shows that, in the

context of electricity generators in the USA, increased marginal costs

were offset by the decline in average costs due to the lump- sum

transfer of the emissions quota. In such a case, although electricity

was produced through cleaner sources, prices on a per-unit basis did

not increase, and there was no signal to consumers to conserve

energy.

• A third requirement for EI to function properly is the effective

pollution monitoring and enforcement mechanism. Obviously, if

emissions fees are to be collected, or if tradable permits are required

to be held to cover emissions, the overall mechanism should remain

cost-effective. For this reason, non-point sources of pollution (such as

agricultural run-off or automobile tailpipe emissions) are rarely if

ever, covered under EI mechanisms. Rather, even developed countries

otherwise embracing EI mechanisms, use command-and-control

regulations (such as best-management practices for agriculture and

catalytic converters for cars).

• Fourth, handling of any violations must be consistent and sufficient to

deter cheating. If polluters, even if detected, know that they can get

away without paying the penalty, will not have any incentive to

reduce pollution. Weak laws, corrupt prosecutors or inefficient courts,

all point towards the inefficient enforcement mechanism; or inability

to book violators through prompt legal recourse (Bell, 2005). There is

in fact a large volume of literature on “optimal enforcement” schemes

(Kwerel, 1977; Segerson, 1988; Kritikos, 2004).

• Fifth and finally, it is important for any environmental policy

instrument to be accepted by the stakeholders. Not all instruments are

familiar or equally acceptable in all cultures. The ground preparation

is important as it took many years before a cap-and-trade system

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could even be tried in the USA, and more years of experience with

early programs before they became widely accepted. Along with

trading in carbon credits, cap-and-trade systems are now used widely

in Europe. On the other hand, pollution taxes, used widely in Europe,

are used infrequently in the USA (Harrington, Morgenstern, and

Sterner, 2004). Whatever the reason, the important point is that not all

instruments fare equally well in all cultures, even in the similar

economic conditions.

We have so far, focused on requirements for EIs to be effective. However,

one should not leave the impression that, wherever any of these requirements are not

fully met, EIs will be a total failure, or that CAC or other non-revenue and regulatory

instruments are preferable. Each requirement is that one of degree, and must be

assessed qualitatively. Moreover, many of these considerations are as well, important

for proper functioning of CAC instruments. For example, a traditional CAC regulation

requiring the installation of some specific pollution-reducing equipment too will fail if

violations of the regulation are not detected and booked by enforcement agencies.

Policies must accordingly, be evaluated on a case-by-case basis, and conclusions will

no doubt vary for different societies and environmental concerns.

4.3 DESIGNING ENVIRONMENTAL POLICY IN A FEDERAL SYSTEM

The above discussion shows that the standard analysis of environmental

policy does not take into account the level of government addressing the problem, and

it also does not take into account either the interactions among jurisdictions at the

same level of government, or the interactions across levels in a federal setup.

Similarly, the standard analysis of the division of fiscal responsibilities does not

account for the environmental consequences of those relationships. In this section, we

draw on the relevant literature to consider the appropriate role for various levels of

government internalizing externalities in different settings. Specifically, we apply the

above insights on EIs and insights from the last chapter on fiscal federalism to the

question of what level of government is best situated to address which environmental

concerns. We begin with two considerations drawn from the literature on EIs, and

then turn to additional insights from the literature on fiscal federalism.

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First consideration is that, to work effectively, EIs must be backed up by

governmental monitoring and enforcement. Central or local governments may differ

in these abilities. Depending on how enforcement activities are funded (e.g., out of

pollution penalties versus out of general revenues), the level of government with more

resources may have the advantage. Likewise, the level of government that has the

legal authority to enforce violations also may have the advantage. Similarly, the level

of government that is freer from corruption may be better poised to enforce EIs. This

level could be the central government because it may be less beholden to particular

interest groups, or the local governments because they look more accountable to local

population. Clearly, the factors discussed earlier have differing consequences, on a

case- by-case basis, for which level of government is most appropriate to operate a

given instrument or which instrument is most appropriate for a given level of

government.

A second consideration is that market-based EIs have the advantage when

there is substantial cost heterogeneity. If all relevant agents are (nearly) identical, a

one size- fits-all policy would be perfectly appropriate. However, when agents differ

in, say, the costs of pollution abatement, there will be efficiency gains from the

flexibility that EIs provide in accommodating who abates pollution to what extent. By

the same token, a cap-and-trade policy in particular will have its advantage when there

are more (and increasingly different) firms involved in the trading. For this reason, a

cap-and-trade program will do better if implemented at the national or global level

rather, to have multiple unconnected trading umbrellas at the sub national levels.

Our next two considerations come from the literature on fiscal federalism. If

“emissions control” (or environmental quality) is considered a government

expenditure responsibility, which level of government should be assigned this

responsibility? As with the analysis of expenditure responsibilities, an important third

consideration is that the appropriate level of government at which to address an

environmental concern needs to be determined by the geographic scope of the

externality.

Following Oates (2002), we can classify pollution as being one of three types;

see also Braden, Folmer, and Ulen (1996), Anderson and Hill (1997), and Farber

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(1997) for relevant discussion. In first type, the overall level of environmental quality

for the nation as a whole depends upon the aggregate level of “perfectly mixing”

emissions from all areas. The actual level of environmental quality in a particular area

may vary across localities, depending on say, local weather conditions. Even so,

however, it is the total amount of emissions from all jurisdictions that determines the

exact level of environmental quality in any given local area. Examples include global

climate change and the depletion of the ozone layer, where indeed aggregate

worldwide emissions determine the environmental damage at a given location.

Second type of pollution is one in which the amount of emissions in a given

locality i depends only upon the emissions in that locality; that is, emissions in locality

i impose costs on residents and businesses in locality i, but there are no spillovers

from the pollutants beyond the locality itself. An example of this second type of

pollutant is the effects of local pollution discharges on the water quality in the locality,

with no spillovers to other jurisdictions (i.e., where the water basin lies entirely within

the jurisdiction). A second example is the collection and disposal of municipal solid

waste.

In the third type of polluting activity, local emissions in locality i have

harmful effects in that locality, as well as spills over to at least some surrounding

jurisdictions, without necessarily creating an “aggregate” externality. Similarly,

pollutants from some other neighboring localities j≠i spill over into jurisdiction i to

create a level of environmental quality in i that depends upon not only emissions from

i but also from other surrounding jurisdictions. In practice, this third type of

emissions, which lies between the two extremes, seems likely to be the most common.

Examples include acid rain and shared water resources.

In determining the appropriate level of government at which to address an

environmental concern, a third consideration therefore, is the type of polluting activity

among the three types under consideration. In the first type, where the overall level of

environmental quality for the nation as a whole depends upon the aggregate level of

emissions from all local areas, it is the national government that ought to be assigned

the responsibility for the level of environmental quality, since overall environmental

quality depends upon the emissions from all jurisdictions; that is, the provision of

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environmental quality has the characteristic of a pure public good at the national level,

and only the central government can (or will) consider the full import of such

emissions.

However, in the second case, one might argue that it is the local government

in each jurisdiction that should be assigned the responsibility for determining the

efficient level of environmental quality. Because local emissions do not spill over to

any other localities, the local government should be able to determine the efficient

level of the purely local public good, in the form of environmental quality. Uniform

national standards seem likely to be inefficient because they will not allow local

governments to adjust environmental quality either to the demands of their inhabitants

or to local conditions that affects the optimum cost of pollution control.

The third case is the most difficult, where local emissions in locality i have

harmful effects (or benefits) in that locality and these emissions spill over to some

(though not all) surrounding jurisdictions. It is unlikely that each locality will consider

fully the effects of its emissions on the surrounding areas, and so it seems unlikely

that the efficient level of emissions (and of environmental quality) will be achieved in

each locality. However, the precise form of market intervention is unclear in such a

scenario.

In all three types of environmental concerns, especially in the first and third

cases, there is some chance that a local government may choose inefficiently “small”

levels of environmental quality, in an attempt to attract mobile capital from other

jurisdictions. This is the expenditure equivalent of the tax-side race to the bottom, in

which local governments compete with one another to attract businesses, now by

lowering environmental standards rather than by lowering taxes. In this regard, a

fourth and final consideration for determining the appropriate level of government for

dealing with pollution is that the potential for an environmental race to the bottom,

and other strategic interactions among governments, must also be taken into

consideration.

This issue parallels the question of a tax competition among local

governments. Not surprisingly, as with the literature on tax competition, the potential

for such a race to the bottom remains a matter of debate. It has frequently, been

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demonstrated that competition among local governments can lead to inefficient

outcomes, largely because local governments attempt to compete for mobile capital by

offering fiscal incentives (e.g., lower taxes, lower emission standards) to businesses in

a race to the bottom (Zodrow and Mieszkowski, 1989). Perhaps, it can also be

demonstrated that even in presence of fiscal competition among local governments,

local fiscal choices can sometimes achieve efficiency (Oates and Schwab, 1988).

The final outcome between these diametrically opposite conclusions depends

largely upon the types of tax instruments that are available to local governments, the

composition of the electorate, and assumptions made about the presence (or absence)

of strategic behavior of local governments. In any case, the possible existence of a

race to the bottom in environmental quality is a factor generally in favor of a more

centralized assignment of emissions control (Oates, 2002; Dalmazzone, 2006).

Having said so, the ultimate result depends both on the nature of the

environmental concern and the political behavior of local governments. For example,

Markusen, Morey, and Olewiler (1995) consider a world in which there are just two

jurisdictions and one monopolistic and polluting firm. The firm has to decide about

the jurisdiction to locate it on the basis of respective environmental stringency.

Because of transportation costs, consumers obtain the factory's output at lower costs if

the factory is located within their jurisdiction; on the other hand, they are also in such

a case, exposed to the local pollution. In this model, if environmental costs are lower

than the gains to consumers from being nearer to the factory, the two jurisdictions will

compete to host it by lowering their environmental standards below the optimum

level. However, if environmental costs are higher than the gain to consumers of lower

prices, jurisdictions will, somewhat surprisingly, compete to raise their standards

above the optimum level, trying to keep the pollution at a bay while still enjoying the

imported product. Far from a race to the bottom, this case could lead to a “race to the

top” scenario.

Markusen, Morey, and Olewiler (1995) reach to similar conclusions as trade

allows jurisdictions to reap the benefits of firms’ production san pollution. The

jurisdictions do not care about the monopolistic firm’s profits, as they can still capture

such profits through the tax on the product. Oates and Schwab (1988) likewise assume

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that the pollution is only local, but the offsetting interests are those of workers rather

than consumers. In their central model, all workers work in the polluting industry. In

this case, there are no inter-jurisdictional externalities, and voters in each jurisdiction

balance the costs of pollution against the gains in wages, a conclusion that would be

strengthened by adding Tiebout's mechanism of households who vote with their feet.

Jurisdictions that set environmental standards too stringently lose residents, who seek

better jobs elsewhere. By the same token, jurisdictions that set standards too loosely

may also lose residents as they seek better amenities elsewhere.

Oates and Schwab (1988) also show that this conclusion can be weakened by

a variety of auxiliary assumptions. First, to the extent that the pollution has cross-

border effects, local jurisdictions would not be expected to take these into account.

Second, jurisdictions may be forced to levy other (non-environmental) taxes on the

industry to raise revenue; in this case, jurisdictions may compensate by lowering

environmental standards. Alternatively, not all of the population work for the

polluting industry. In this case, the population will be divided into a group that cares

only about the environment and a group that values both, and the optimal level of

environmental stringency is a compromise (or balance) between the two positions,

even though one group may win totally in the political solution.

Finally, government officials may care more about the size of their budget

than the welfare of citizens, an especially important consideration if the model is to be

applied to a non-democratic society. In this case, officials may lower environmental

standards to maintain the tax base. However, this factor could work the other way if

local jurisdictions employ a Pigouvian tax for the industry, rather than CAC

regulations. If local governments cannot or will not provide adequate environmental

protection, say, because of competition for mobile capital or because they do not

adequately account for inter-jurisdictional environmental spillovers, central

governments may need to play a larger role.

In no way, this means implementing environmental policy by the federal

government. Instead, just as with other public expenditures, the central government

can increase the level of environmental protection via providing matching grants to

local jurisdictions (Alm, 1983; Oates 1999). Silva and Caplan (1997), and Nagase and

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Silva (2000) show that by making redistribution conditional on local welfare (which

in turn may be a function of all jurisdictions’ emissions), central governments can

induce local governments to take transboundary externalities into account. This is a

meaningful insight, because it suggests that central governments have tools at their

disposal that they can deploy without knowing anything about abatement costs, the

optimal way to abate in a local setting, or even the extent of transboundary

externalities. So long the local governments are aware of externalities; the central

government need only observe outcomes.

When evaluating various models, the question should not be so much which is

the “best” but rather which is the most relevant option to a specific region and to a

specific environmental concern. Does the pollution crosses jurisdictional boundaries?

Do citizens gain materially from the existence of the polluting industry? Is the

industry mobile? Can the central government provide matching grants or other forms

of incentives? These and other questions must be considered. We must also look into

the empirical evidence on these questions. The likely outcomes of such inter-

jurisdictional competition have been tested empirically for at least two cases of the

third type of environmental concerns that spills over across jurisdictions: air quality

and rivers.

In the case of water quality, Sigman (2007) had studied pollution readings

between 1979 and 1999 at 47 countries with multiple pollution monitors on their

rivers. She finds some weak evidence that average pollution concentrations are higher

in countries with federal systems and/or with more decentralized public expenditures,

consistent with a race to the bottom prognosis. Interestingly, Sigman (2007) also finds

that more federal countries have greater variability in pollution across locations,

which is consistent with the idea that differences in populations’ tastes or in firms’

cost structures would be accommodated better by decentralized policies than by

centralized ones.

Similarly, in a study of pollution from U.S. pulp and papers mills subjected to

state-level regulations and enforcement, Gray and Shadbegian (2004) find that both

air and water pollution emissions are lowest where the damages are likely to be

highest (e.g. because of a more dense local population). This result is also consistent

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with the greater flexibility afforded by local rather than national policy. A particularly

important question is the extent to which governments account for cross-border

externalities in their policies. Sigman (2002) finds worse pollution on international

rivers than on domestic rivers, with the exception of EU countries where cooperation

among states might have been greater accounting for this outcome.

The United States also provides an important opportunity to look at these

questions because of its federal system. In the environmental policy of the USA, the

federal government typically mandates standards of environmental quality that must

be met, but allows some degree of discretion on the part of individual states to

implement and enforce these standards. The Clean Water Act created a process

whereby some states were “authorized” with more discretion than others. In that

context, Sigman (2005) finds little over-all effect of having more discretion on

average pollution levels in a state’s rivers. However, she does find a small effect of

state discretion on downstream states or on rivers that form a shared border. In other

words, where the inter-jurisdictional spillovers are strongest, states that have

discretion seem to free ride.

A similar result comes from a study of the pattern of air and water emissions

from the largest pollution sources in the USA. Helland and Whitford (2002) find that

both types of emissions are higher in border counties than in non-border counties.

Since emissions near a border are more likely to spill over into neighboring

jurisdictions, this finding suggests that states either are selectively enforcing

regulations or are authorizing permits in a way that encourages such spillovers.

Bluestone (2007) examines a similar issue, where higher level of “governmental

fragmentation” in Metropolitan Statistical Areas (MSAs) leads to worse

environmental outcomes. Fragmentation refers to the number of local governments in

a given census-defined region. While the federal government sets environmental

standards for air quality and the states determine how those goals are to be met,

individual local jurisdictional policy can still have direct and indirect effects on

outcomes. Individual jurisdictions can help or hinder regional environmental goals

through control of land use, budgets and municipal programs. The empirical results

suggest that local governmental fragmentation does hinder MSAs from attaining the

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stipulated ozone standard, a result consistent with the notion that local governments

do not fully consider the effects of their policies on other neighboring jurisdictions.

Finally, an important test case arose for the USA in the 1980s, when states

were given substantially more discretion (and less assistance from the federal

government) under Reagan’s “new federalism”. List and Gerking (2000), and

Millimet (2003) study the effect of this devolution of authority, and find that it had

little effect on (actually increased) expenditures on pollution abatement and air

quality. Furthermore, Fredriksson and Millimet (2002) find no consistent pattern of a

states’ environmental stringency on that of its neighbors.

The overall message through these studies appears to be that there is little

evidence of a substantial “race to the bottom” from decentralized environmental

policies. However, these studies also suggest that local jurisdictions tend to discount

the importance of pollution on their neighbors. Thus, the evidence confirms the

economist’s intuition that centralized policies will be especially important where the

spillovers are largest.

The foregoing discussion on environmental policy is particularly biased

towards negative environmental externalities and focuses on the principle of polluter

pays. Similar to the polluter pays principle; there is the concept of compensation for

environmental services. Compensation is paid to the provider of positive externality.

Compensation for environmental services (CES)3 helps in internalizing the

environmental externalities through the transfer of financial resources from

beneficiaries of certain environmental services to those who provide these services.

Effectiveness of the CES system is contingent on the premise that the ecosystem

managers – individuals and communities – have appropriate property rights and the

benefits of the services remain confined to only those who pay for the services (Engel

et al., 2008). For the natural resources such as forests, property rights generally vest

with the local or regional governments and there are positive spatial externalities in

the conservation activities. As a result, these regional governments spend less than

3 For the definition of terms payment for environmental services (PES), CES, market for environmental services, and reward for environmental services and difference between them, see appendix of Wunder (2006). We use PES and CES interchangeably.

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required and the commodity in question remains underprovided. For example, in a

study of federal and state spending under the Endangered Species Act in the USA,

List et al. (2002) find the states tend to spend less relative to the federal government

on those species that demand a larger habitat area and whose preservation cause

conflicts with other economic development.

Similarly, Gray and Shadbegian (2004) find evidence of higher water and air

pollution when out-of-state residents get a larger share of benefits of pollution control

measures. This necessitates the need for broadening the scope of CES mechanism, i.e.,

local/regional governments need to be compensated for the opportunity costs borne by

them (over and above their benefits) for managing the natural resources.

Intergovernmental fiscal transfers are an innovative way of compensating the

local and state public actors for their ecological public functions (Kumar and

Manangi,2009). Such transfers redistribute the public revenue from federal and

regional governments to local governments. Traditionally these transfers are used to

compensate local governments for expenditure incurred in providing public goods and

services with spillover benefits to areas beyond their boundaries. Ecological

functions4 performed by a sub-national government are the classic case of spatial

externalities. Neglecting ecological functions in the fiscal transfers causes two fold

effects – inadequate incentives/compensation to those conserving natural resources on

the one hand, and lack of disincentives to those frittering away such precious

resources on the other hand. Fiscal transfers can be an inducement for local

governments not only to support and maintain the quality of water and nature

protection areas within their territories, but also to provide wider environmental

benefits beyond their boundaries. Fiscal transfers designed to encourage the optimal

provision of environmental services is expected to depend upon the level of associated

externalities (Bird and Smart, 2002).

4Environmental services or “ecological public functions consist of the protection and sustainable use of natural resources, living organism, ecosystems and landscapes.” These also include negative impacts of human activities on the environment in the form of environmental pollution such as emissions, waste and contaminated sites, impaired or destroyed landscapes among others (Ring, 2002).

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Local public goods and services are provided more efficiently when resource

allocation decisions are limited to the lowest governmental level (Oates, 1972).

Decentralization introduces intergovernmental competition and checks and balances

(Breton, 1996), and reduces coordination and transactions costs. Note that the

decentralization rule in resource allocation is applicable in the absence of economies

of scale and externalities. Following the decentralization rule, lower levels of

governments are assigned the task of protecting the environment where appropriate.

There are numerous studies realizing that decentralization works much better in

environmental protection than the top-down mechanism (e. g, Chopra et al., 1990).

Presence of spatial externalities in the provision of environmental services calls for a

differentiated approach in executing the decentralization rule. Appropriate solutions

have to be sought according to the specific characteristics of the various

environmental problems. This is reflected in the debate “regarding the competencies

of the national or even supranational governmental level versus the state or local level

in environmental standards setting” (Ring 2008a).

Highly mobile environmental services and pollutants easily cross

administrative boundaries and create far reaching spatial externalities; and require

more centralized solutions (Ring, 2002). For example, the issue of climate change

requires centralized solutions if not global policies. Similarly, public goods such as

basic and applied research, including the development of environmental policy

instruments, and also the dissemination of information on harmful environmental

impacts or the development of pollution control techniques tend to be underprovided

at decentralized levels (Oates, 2001). In contrast, an environmental policy associated

with less mobile environmental services/pollution is better suited for assignment to

decentralized levels of government (Oates, 2001).

Sigman (2005) estimates the environmental costs of water pollution generated

downstream due to free riding states when rivers cross state boundaries in the United

States and finds that free riding gives rise to a 4 percent degradation of water quality

downstream of authorized states. Helland and Whitford (2003) find toxic chemical

toxic releases to be higher in border counties. Trans-boundary air and water pollution

is associated with negative externalities; priority areas for water protection can

involve positive externalities. Water protection zones are generally located in rural

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areas and villages bear the costs of protection, but provide water services mainly to

urban areas far beyond their boundaries. Conservation and sustainable use of

biodiversity is another example of spatial externalities (Perrings and Gadgil, 2003).

Spatial scale and mobility are very important determinants of species protection. List

et al. (2002) find the phenomenon of free riding on the part of the states under the

Endangered Species Act in the USA. These examples reveal that the misallocation of

resources cannot be avoided simply by assigning the task at appropriate level because

mere assignment does not provide adequate incentives for internalizing the

externalities. Rewarding local governments for their conservation efforts is necessary

to reconcile both local and global public benefits of conservation of natural resources

(Perrings and Gadgil 2003, Millennium Ecosystem Assessment, 2005, Ring 2008a).

4.4 ENVIRONMENTAL FEDERALISM IN INDIA

Environmental issues in India as elsewhere had broadly, been identified as

‘management and conservation of natural resources’ and ‘environmental concerns due

to uncontrolled release of industrial pollutants into the air and water bodies’ often,

known as the ‘green’ and ‘brown issues’. Environmental risks could arise due to

industrial growth as well as, exacerbated poverty. In addition to physical activities,

any policy distortions also lead to certain environmental risks (XIII FC). Natural and

environmental resources generally describe all the elements available in nature that

are used or can be used in the economic system. Such resources could be renewable /

non-renewable and recyclable / non-recyclable needing differential treatment.

Environmental concerns arise mainly from the impacts of human activities and leads

to various forms of pollution (from point / non-point sources) and resource

degradation (FAO Handbook). Environmental issues like elsewhere, are often

classified as local (ground water and vehicular pollution) and global (climate change,

conservation of Stratospheric Ozone Layer, and biodiversity etc.). In addition to these

two categories, externalities such as surface water pollution and submergence of land

in other states due to projects in a state on interstate rivers qualify as interstate

(regional) environmental issues. These externalities have a definite bearing on

interstate relations and need to be considered within the framework of the federal

structure.

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As environmental concerns and causes are interconnected, genesis of the

global environmental issues lies with actions at the local levels. It is, therefore,

important that the sub national governments should be adequately compensated for

their positive externalities and vice versa. A prudent federal system should need to

allocate responsibility of tackling environmental issues and to earmark financial

resources for that at the appropriate level of government. Externalities also need to be

factored in intergovernmental fiscal transfers to check ‘free riding’ by states.

Having said so, let us explore the magnitude of environmental federalism in

India. Environmental conservation had been imbibed in the ethos of Indian population

ever since ancient times. As far as modern legal instruments are concerned, the Indian

Forest Act, 1927 predates Indian independence. Subsequently, environment related

issues had been incorporated in the Indian Constitution through various amendments.

Article 48 A (inserted by 42nd Amendment in 1977) of the Constitution stipulates that

the State shall endeavor to protect and improve the environment and to safeguard the

forests and wild life of the country. Interestingly, environment as a subject do not find

mention either in the List-I (Union list) or List-II (State list) of the Seventh Schedule.

The Union list includes subjects related to the environment such as interstate

rivers and river valleys, mines and minerals, oil fields, atomic energy, air traffic,

fishing and fishery beyond territorial water, shipping and navigation, of inland

waterways, maritime shipping and navigation and entering agreements with foreign

countries. The State List contains the subjects that are either directly related to or have

some bearing on the conservation of natural environment, that is, public health and

sanitation, agriculture, land improvement, water supplies, irrigation and canals,

drainage and embankment, water storage and hydropower, and fishery.

The subjects such as forests and wildlife, electricity, factories, shipping and

navigation on inland waterways as regards mechanically propelled vessels figure in

the Concurrent List. The entries, ‘population control and family planning’, ‘forests’

and ‘protection of wild animals and birds’ were shifted to the Concurrent List from

the State List by the Constitutional (42nd Amendment) Act, 1976. These amendments

gave more power to the centre to legislate on environmental issues. The centre can

also legislate on any subject of the State List in the ‘national interest’ (Article 249)

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and Article 252 empowers the centre to enact laws on state list if two or more state

legislatures consent to such legislation. This centripetal bias in the Indian Constitution

reveals a dominant role of central government in all matters including environmental

legislation (Gupta 2001, Mandal and Rao 2005).

Reverting to the third tier of government in India, the Eleventh and Twelfth

Schedules to the Constitution list out the subjects respectively, reserved for the rural

and urban local governments. The environmental functions listed for the rural local

governments include land development and soil conservation, water management and

watershed development, social forestry, farm forestry and non-timber forest products;

fuel and fodder; and non-conventional energy sources. For urban local bodies the list

includes subjects like water supply for domestic, industrial and commercial purposes;

public health, conservancy and waste management; and urban forestry, protection of

environment and promotion of ecological aspects. However, it is not mandatory for

the states to devolve some or all of the listed functions (Rao, 2000) that results in wide

variation across the Indian states in the range and nature of environmental functions

assigned to and discharged by local bodies. Despite various constraints, local

governments do perform some environmental functions such as conservation services,

health, street lighting, water supply and sanitation related activities to varying degrees

in various parts of the country.

Based on the aforesaid discussion, it could be concluded that the assignment

of environmental power in Indian federalism is reasonably clear. However, dispute

resolution mechanism for environmental issues (inter-state river water sharing and

water pollution) is not very effective and is time consuming. Broadly speaking, while

the central government has the responsibility of determining the overall environmental

policy framework including handling international negotiations; and provides a major

chunk of financial resources, the sub-national governments are involved in

implementation of programmes. The assignment system attempts to minimize

transaction costs by providing sufficient scope for decentralized governance of

environmental functions in India. At the same time, the central government has

overriding powers to avoid unhealthy competition and institutional mechanisms to

resolve inter-state disputes (Mandal and Rao 2005). However, the mechanism for

handling of interstate environmental externalities as demonstrated by protracted and

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growing numbers of interstate water disputes is either non-existent or ineffective in

the country.

In addition to the role played by the Union and states, the Supreme Court had

been extremely active forcing governments to implement various environmental

provisions by responding to public interest litigations (PILs), by taking suo moto

cognizance of various issues, and by setting up the Central Empowered Committee

(CEC) on Environment. Taking a cue, various High Courts too, have designated

‘green benches’ and had pronounced judgments on environmental matters in the

country. As a case in point, the Supreme Court (the Order dated 30 October 2002 and

1 August 2003 in IA No. 566 in WP (C) No. 202 / 95) had directed that the state

government should charge the Net Present Value (NPV) of the forest area diverted for

developmental projects from the user agency. Following this order, MoEF had issued

guidelines (vide letters No. 5-1/1998 –FC (Pt. II) dated 18 September 2003 and 22

September, as well as letter No. 5-2/006- FC dated 3 October 2006) for various

developmental projects including even those promoted by the public sector. The

payment of NPV in addition to the cost of catchment area treatment plan, and the cost

of raising and maintaining compensatory afforestation; providing double the extent of

non forest land for afforestation in lieu of according forestry clearance as per the

Forest Conservation Act 1980, had made available additional resources beyond

mandated by either the Parliament or state Legislatures for forestry and wildlife

conservation, and for other environmental purposes in the country.

As far as environmental law making is concerned, Article 253 of the

Constitution empowers the centre to make laws necessary to implement treaties to

which India is a signatory and decisions of international conferences of which India is

a participant. Most of the legislation in the field of environment had been done under

these provisions. For example, the two major environmental laws in India, namely, the

Air (Prevention and Control of Pollution) Act 1981 and the Environment (Protection)

Act 1986 have been legislated under this provision citing the United Nations

Conference on the Human Environment (UNCHE) held in 1972. Similarly, the

National Environmental Tribunal Act 1995, the National Environmental Appellate

Authorities Act 1997, and the Biodiversity Act 2002 were enacted pursuant to the

United Nations Conference on Environment and Development (UNCED) of 1992.

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The Water (Prevention and Control of Pollution) Act of 1974 and the Water

(Prevention and Control of Pollution) Cess Act of 1977 are two other important

legislations in the country. The nature of 1974 Act is basically a “command and

control” regulation. The major lacuna of 1974 Act is the absence of provisions for the

funding of State Pollution Control Boards (SPCBs). The 1977 Act attempts to address

the issue of funding SPCBs. However, it would be appropriate to clarify that the

water cess levied under the Act is not a pollution tax and is not levied on

environmental externalities per se.

4.5 STATUS OF NATURAL RESOURCES IN INDIA

We now briefly dwell upon the precarious status of natural resources in India

in subsequent paragraphs. This deliberation points out towards urgent remedial

measures to be taken in the country for ensuring environmental integrity crucial for

overall sustainability.

4.5.1 Land Degradation

In India, an estimated 146.82 Mha area suffers from various forms of land

degradation due to water and wind erosion and other complex problems like

alkalinity/salinity and soil acidity due to water logging (Figure 4.1). The varying

degrees and types of land degradation stem mainly from unstable use and

inappropriate land management practices. Loss of vegetation occurs as a result of

deforestation, cutting beyond the silviculturally permissible limits, unsustainable fuel-

wood and fodder extraction, shifting cultivation, encroachment into forest lands, forest

fires and over-grazing, all of which subject the land to degradational forces. Other

important factors responsible for large-scale degradation are the extension of

cultivation to lands of low potential or high natural hazards, non-adoption of adequate

soil conservation measures, improper crop rotation, indiscriminate use of agro-

chemicals such as fertilizers and pesticides, improper planning and management of

irrigation systems and extraction of groundwater in excess of the recharge capacity. In

addition, there are a few underlying or indirect pressures such as land shortage, short-

term or insecure land tenancy, open access resource, economic status and poverty of

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the agriculture dependent people which are also instrumental, to a significant extent,

for the degradation of land (SoE, 2009).

Fig 4.1: Extent of Various Kinds of Land Degradation in India

Source: State of Environment Report, 2009

4.5.2 Ambient Air Quality Trends

Central Pollution Control Board implements a nation-wide programme of

ambient air quality monitoring known as National Air Quality Monitoring Programme

(NAMP). The network for this purpose consists of 342 monitoring stations covering

127 cities/towns in 26 States and 4 Union Territories of the country (SoE, 2009). The

country-wide ambient air quality monitoring carried out by CPCB at 201 monitoring

stations revealed that National Ambient Air Quality Standards (NAAQS) for

Respirable Suspended Particulate Matter (RSPM), the main air pollutant of public

health concern, were violated at most of the monitoring stations (MoEF, 2005). The

estimated annual economic cost of damage to public health from increased air

pollution, based on RSPM measurements for 50 cities with the total population of 110

million, reached USD 3 billion (Rs.15,000 crores) in 2004. Air quality data and trends

highlight an emerging phenomenon of conflicting trends for different categories of

cities, similar to that experienced by many other countries, thereby reflecting the

complex forces behind the impact of growth on environmental action and outcome.

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4.5.3 Water Pollution

Water pollution is a serious problem in India as almost 70 per cent of its

surface water resources and a growing percentage of its groundwater reserves are

contaminated by biological, toxic, organic and inorganic pollutants (MoWR 2000). In

many cases, these sources have been rendered unsafe for human consumption as well

as for other activities such as irrigation and industrial needs. This illustrates that

degraded water quality can contribute to water scarcity as it limits its availability for

both human use and the ecosystem. In 1995, the Central Pollution Control Board

(CPCB) identified severely polluted stretches on 18 major rivers in India (World Bank

1999). Not surprisingly, the majority of these stretches were found in and around large

urban areas. The high incidence of severe contamination near urban areas indicates

that the industrial and domestic sector's contribution to water pollution is much higher

than their relative importance, implied in the Indian economy. Having said so,

agricultural activities also contribute in terms of overall impact on water quality.

Besides rapidly depleting groundwater table in different parts, the country faces

another major problem on the water front – groundwater contamination - a problem

which has affected as many as 19 states, including Delhi. The geogenic contaminants,

including salinity, iron, fluoride and arsenic have affected groundwater in over 200

districts spread across 19 states.

India does have a robust centralized water pollution monitoring network.

CPCB in collaboration with State pollution control boards established a nationwide

network for water quality monitoring comprising 1,019 stations in 27 States and 6

Union Territories. The monitoring is undertaken on a monthly or quarterly basis for

surface water and on a half yearly basis for groundwater. The monitoring network

covers 200 Rivers, 60 Lakes, 5 Tanks, 3 Ponds, 3 Creeks, 13 Canals, 17 Drains and

321 Wells. The water quality monitoring results obtained between 1995 to 2006

indicate that organic and bacterial contamination continues to be critical in water

bodies. This is mainly due to discharge of domestic wastewater mostly in untreated

form from the urban centres of the country. The municipal corporations at large are

not able to treat the wastewater, increasing municipal sewage load flowing into water

bodies without treatment. Secondly, the receiving water bodies also do not have

adequate water for dilution, because of which the oxygen demand and bacterial

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pollution is depicting an increasing trend and leading to water borne diseases. The

water quality monitoring results were analyzed with respect to the indicator of organic

matter (Biochemical oxygen demand) and indicator of pathogenic bacteria (total

coliform and faecal coliform). The result of such analysis shows that there is gradual

degradation in water quality.

As stated earlier, water in India is governed under three different Acts: the

Environmental Protection Act (1986), the River Boards Act (1956) and the Inter-State

Water Disputes Act (1956). Other Acts and Regulations affect water resources in

different ways by addressing its importance for agriculture, biodiversity and

conservation and drinking water. These three Acts, however, have the broadest scope

in terms of how they affect all aspects of water management.

4.5.4 Biological Diversity

Traditional and substantial dependence on biodiversity resources for fodder,

fuel wood, timber and minor forest produce has been an accepted way of life for the

rural population that accounts for nearly 74 per cent of India's population. With

radical demographic changes, the land to man ratio and forest to man ratio has rapidly

declined. The lifestyles and the biomass resource needs having remained unchanged,

the remnant forests have come under relentless pressure of encroachment for

cultivation, and unsustainable resource extraction rendering the very resource base

unproductive and depleted of its biodiversity. Coupled with these incongruities and

aberrations in land use, the unsound development strategies have led to increasing

threats to biodiversity resources by way of illegal encroachment of 0.07 Mha of forest,

cultivation of 4.37 Mha and diversion of forest for river valley projects (0.52 Mha),

industries and townships (0.14 Mha), transmission lines and roads (0.06 Mha) and an

additional 1.5 Mha for miscellaneous purposes (TERI, 1999).

The unabated pace of development of infrastructure to harness hydropower,

driven by necessity to meet the growing requirements of water for inputs to irrigation,

domestic use and industrial purposes, has led to the construction of over 4,000 dams

across India. The creation of valley bottom reservoirs in wilderness areas has brought

on the destruction of some of the finest forests and biodiversity-rich unique

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ecosystems. Deforestation due to hydropower and mining projects are perhaps the

greatest threats to biodiversity in India.

4.6 NEED FOR INTERGOVERNMENTAL FISCAL TRANSFERS ON ENVIRONMENTAL CONSIDERATIONS IN INDIA

In order to respond to the question about the necessity to integrate

environmental externalities in the intergovernmental fiscal transfers, it is important at

this stage, to consider precarious status of environment and natural resources despite

having a robust legal and policy framework in India. The following two sub-sections

present a disturbing picture of two important natural resources namely, lakes and

wetlands, and forests in the country. This is only an indicative and not the exhaustive

treatment of the status of natural resources with a purpose to emphasize the need for

inclusion of ecological considerations in the intergovernmental fiscal transfers in

India.

4.6.1 Conservation of Lakes and Other Water Bodies:

Annual average available estimated water resource of the country is 1869

BCM. Within the limitations of physiographic conditions, socio political environment,

constraints and the technology available at hand, the utilizable water resources of the

country has been assessed as 1123 BCM, of which 690 BCM is from surface water

and 433 BCM from ground water sources. Due to spatial and temporal variations,

harnessing of 690 BCM of utilizable surface water is possible only if matching

storages are built to the required extent. (Task Force on Irrigation, Planning

Commission, 2009). There has been an inseparable relationship between the rural

economy and wetland resources, as wetlands are integral and key components in food

and water security. A significant population of India has been living on the wetland

resources for ages, rather harmoniously, devising indigenous methods in safeguarding

and augmenting water resources. The disharmony arises due to neglect and the over

use of resources. The rapidly expanding human population, large scale changes in

land use/land cover, the burgeoning development projects, dumping of industrial

effluents and solid wastes and improper use of watersheds have led to the decline of

wetland resources of the country.

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The alarming pace of disappearance of wetlands from the landscape of India

is of great concern. It is estimated that by 2050, the freshwater biodiversity will have

a drastic decline relative to other biomes (Biodiversity Action Plan, MoEF, 2002).

Reliable and updated information on the extent of wetlands, their biodiversity values,

ecosystem service values and socio-economic importance are vital for evolving long-

term conservation policy, legislation and administrative interventions. Currently,

neither there is an appropriate institutional mechanism to address this issue nor does

India have an information channel in place to generate and update status of water

bodies periodically. Moreover, only a few of the ecologically sensitive wetlands are

protected by the Wildlife Protection Act while the rests are becoming an easy target

for anthropogenic exploitation.

The most startling findings of “Inland Wetlands of India – Conservation

Priorities: 2004” (MoEF/UNDP) are the loss of wetlands and the amount of pollution

in the remaining water resources. It reported that the country has lost 38% of the

wetlands in the last ten years and out of 1700 fish studies from 170 wetlands across

the country, none was free from residual pesticides and heavy metals. Other water

related important issues are namely recharging of ground water aquifers; reduction

and recycling of water usage, equitable distribution of water resources, water pricing

and investment in technology for converting saline water into potable water in coastal

areas. Some of the states have taken welcome steps of setting up lake conservation

authorities. Most of these bodies have neither authority over all the water bodies nor

required resources for conservation. This critical situation demands concerted efforts

for the conservation of lakes and other water bodies (tanks, ponds, and other water

harvesting structures) in India.

Lack of institutional and financial resources involving externalities, therefore,

could be attributed to the sordid state of affair of water bodies in India. In case of

water bodies spread over more than one jurisdiction, there is a clear cut case of

involved externalities. Even water bodies lying wholly within a single jurisdiction,

there are externalities per se as the actions of one set of people affect many others

surviving on those resources?

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4.6.2 Conservation of Forests and Other Protected Areas in India

Management of forests in India is mainly responsibility of the respective state

governments and is covered under the Indian Forest Act 1927 and the Forest

Conservation Act 1980. The Wildlife (Protection) Act 1972 is the guiding force for

conserving wildlife in India. Network of conservation sites in India consists of

National Parks, Sanctuaries, Conservation Reserves, Community Reserves, Tiger

Reserves, Bio-sphere Reserves, World Heritage sites and RAMSAR sites. As on

February 2008, 23.68 % of geographical area of India is classified as forest area while

only 4.77 % had been classified as protected areas. These figures are against the

norms of overall 33 % geographical coverage and 66 % area under fragile ecosystems

(mountains and hills) as prescribed under the National Forest Policy (NFP). Out of

total protected areas (613), National parks (97) constitute only 1.16 %, wildlife

sanctuaries (508) 3.61 % and conservation reserves (6) 0.003 % of the geographical

area (MoEF, 2008). The financial resources for forest development largely come from

the central government (Ministry of Environment and Forests, Ministry of Rural

Development) while expenditure on human resources and establishment is borne by

the respective state governments.

Most of the community based institutions engaged in conservation of natural

resources lack financial muscle considerably curtailing their effectiveness. The Joint

Forest Management (JFM), biodiversity committees, watershed committees and

wasteland development committees involving local communities have been functional

in the country for past many years. Many other community based institutions such as

Van Panchayats and Pani Panchayats have also been functioning in different parts of

the country even before that. The informal community based organizations engaged in

protecting sacred groves, managing irrigation tanks and community lands could also

be found in almost every part of the country. All such bodies face resource crunch. It

is a fact that the local communities pay an enormous price in terms of forgone

opportunity cost for conserving forests and other natural resources without deriving

commensurate benefits. The National Environment Policy (NEP) 2006 rightly,

advocates that while conservation of environmental resources is necessary to secure

livelihoods and well being of all, the most secure basis for conservation is to ensure

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that people dependent on particular resources obtain better livelihoods from the

fact of conservation, than from degradation of the resources. This could only be achieved through not only by earmarking additional

resources but also accounting for externalities for the improved livelihoods of

forest fringe dwellers. As mentioned in Chapter 1, natural resource endowment

and their relative conservation measures vary across different states in India.

The states having proportionately large portion as forests and protected areas,

while forgoing opportunity costs in terms of alternative land use patterns, offer

positive externalities to other states. Efforts of states providing positive

environmental externalities need to be recognized and be duly financially

compensated. Forests constitute an important component of livelihood

resources, especially for the tribal people and those living in and around the

forest fringes (estimated to be around 100 million people), and also provide

environmental benefits such as watershed protection, prevention of soil and

water run-off, ground water recharge, purification of air and water by acting as

a sink for greenhouse gases, conservation of genetic resources and

biodiversity, recreational services and aesthetic value. Despite having a

plethora of forests and wildlife conservation schemes under implementation for

quite some time in a significant protected area network in the country, our

track record leaves much to be desired. As per various assessments of Forest

Survey of India (FSI), condition of forests are deteriorating over a period of time in

terms of area, tree cover and conservation of wild life despite in existence of the

Forest Conservation Act.

It could be argued that degradation of natural resources cannot be avoided

simply by assigning the task at appropriate level; and genesis of degradation can be

found in the incentives structure of governance (Mandal and Rao 2005). As of now as

far as intergovernmental fiscal transfer system that exists in India, it provides neither

incentives for conserving natural resources nor disincentives for frittering them away

by the sub national governments.

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4.7 INTERGOVERNMENTAL FISCAL TRANSFERS FOR THE ENVIRONMENT IN INDIA

As mentioned in Chapter 3, overall transfers from the Finance Commissions

in India are in two categories namely, devolution of central taxes and duties, and

grants-in-aid to states and local bodies. Some grants-in-aid are state specific while

most others are formula based grants for different purposes such as disaster relief,

maintenance of roads and buildings, and post-devolution non-plan revenue deficit etc.

Grants-in-aid are generally conditional in India. First eleven Finance Commissions did

not address environmental issues either directly or in any significant manner.

The 12th Finance Commission for the first time in addition to the state specific

grants-in-aid (part of it could also be considered for environmental purposes as given

in Table 4.1) had recommended the direct transfer of an amount of Rs. 1000 crore to

the states for the period 2005 to 2010 based on available forest area within their

jurisdictions. This transfer was in addition to the traditional criteria, such as area,

population, tax-effort, cost of fiscal disability, fiscal discipline, and socio-economic

parameters used by earlier Finance Commissions (GoI, 2005). This initiative by the

12th Finance Commission could be considered as the turning point in the Indian fiscal

federalism for “recognizing area based resource allocation for management of natural

resources”.

With the 12th Finance Commission having acknowledged the need for

devolution of grants for the transfer of resources to promote ecology, a beginning has

been made but it was expected to go to the next level with the incorporation of

ecological considerations into the devolution of shareable resources/grants to states by

the 13th Finance Commission. As far as overall transfer of resources (Rs.17,06,676

crore) was concerned, the 13th Finance Commission had recommended about 84.85%

of it as devolution of central taxes and duties and balance as grants-in-aid to states and

local bodies (GoI, 2010). It had also recommended reduction in the number of

Centrally Sponsored Schemes (CSS) and to restore the predominance of formula

based plan transfers (Para 4.56). In addition to making a quantum jump in terms of

allocating sizable resources directly to both urban and rural local bodies in the

country, it had no doubt, introduced an element of incentive based allocation of

financial resources in the framework of allocation.

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While recognizing that environment being a residual subject, the

responsibility of implementation of various central and state enactments rests with the

state governments and there is asymmetry in the appropriation of benefits and costs

borne of implementing these enactments (para 8.12), the XIII FC restricted itself with

the traditional devolution index considering only population, area, income distance

and fiscal discipline criteria only. It would have been better that the devolution criteria

should have taken into consideration an environmental indicator for the disbursement

of central taxes and duties. The indicator could have reflected both conservation

efforts and the stock of natural resource in a jurisdiction based on a set of measures

that are appropriate to quantify gains.

Addressing environmental concerns, the 13th Finance Commission had

recommended an amount of Rs. 5,000 crore as forest grant (Para 12.46), an incentive

grant of Rs. 5,000 crore for grid-connected renewable energy (Paras 12.52 and 12.53)

and another Rs. 5,000 crore as water sector management grant subject to setting up of

a Water Regulatory Authority and achieving the normatively assessed state-specific

recovery of water charges (Para 12.58).

The formula for disbursement of forest related grants has been designed to

take into consideration three factors (Para 12.45) namely, the share of the total forest

area in the country falling in a particular state, whether the forested area in the total

area of the state is greater than the national average, and lastly the quality of forest in

each state. The quality had been assessed on the basis of moderately and highly dense

forest area in the state. Note that the Commission had required the states to spend at

least 25 % of the forest grants for the preservation of forests in the last three years and

remaining 75 % they are allowed to use for other development purposes; recognizing

the trade-off between conservation and developmental activities.

This formula is definitely an improvement over the simple total forest area

based approach followed by the 13th Finance Commission. In their own admission, the

Commission is of the view that the forest grant is based on the formula that is

essentially a reward for the present stock (Para 12.31) and does not contain other

important factors such as the biological diversity contained within it (Para 12.30). The

Commission hoped that the size of grant will provide the wherewithal for

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conservation so as to halt the degradation and later reverse the trend of decline in the

quantum and quality of area under forests (Para 12.31).

While citing ‘fertilizer subsidy’ at the national level and ‘pricing of electricity

to different sectors’ at the state level as the two most important policy measures

adversely affecting the environment, the 13th Finance Commission had come out with

a solution in terms of providing incentives to states for generation of grid electricity

from renewable sources (Para 12.36). The measure is inherently a welcome step but

falls short of addressing the distortion caused by current policies of providing

‘fertilizer subsidy’ and inappropriate ‘pricing of electricity’.

The third major environmental concern identified by the 13th Finance

Commission has been unsustainable ‘exploitation of ground water’, ‘poor industrial

water use efficiency’ (Para12.37), ‘poor maintenance of irrigation networks’, ‘poor

recovery of water user charges’ and ‘institutional and administrative problems’

associated with the irrigation department (Para 12.38). The Commission had tried to

address this issue by providing grants for the purpose of incentivizing states to

establish an independent regulatory mechanism for the water sector and improved

maintenance of irrigation networks (Para 12.39). The incentive grants for water sector

are an addition to normal maintenance to be incurred by the states. There is no inbuilt

system that this dictate of the Commission will be followed by otherwise resource

starved states in India. Although the Commission had prescribed certain conditions

(Annexure 12.7 and 12.8) prior to releasing water sector grants, everything depends

on efficacy of the so called ‘independent regulator’ and the ‘political will’ of the state

government to enforce and implement orders of the regulator.

In the nutshell, it is prudent to state that the 13th Finance Commission, in their

report had further carried the task forward of intergovernmental fiscal transfers on the

basis of environmental concerns. However, the award of the 13th Finance Commission

did not made any direct attempt to address existing and emerging environmental risks

related to uncontrolled industrial growth; and exacerbated poverty. It only grappled

with policy related environmental risks that too, partially at the central and state

levels; and completely ignored policy related issues emanating at the level of local

bodies both urban and rural.

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Partial handling of policy related environmental risks at the central and state

levels by the 13th Finance Commission could be attributed mainly, due to non-

inclusion of all the related issues (fertilizer subsidy by the central government; free

electricity to farmers by the state governments); indirectly or at best remotely

addressing and linking the concerns of ‘excess ground water extraction’ and

‘inefficiencies involved in using surface water’ with setting up of an ‘independent

water regulator’ by various states. The efficacy and efficiency of such institutions is

yet to be proved and is still in the realm of future. The progress of the ‘independent

water regulator’ will also depend on the political space they get in their respective

states.

According to the 13th Finance Commission, the policy risk to the environment

is not typically found at the local level (Para 12.41). However, implementation issues

such as flouting of municipal zoning laws; illegal construction on drainage channels

etc., have direct bearing on the environment. These issues though highlighted, had not

been adequately reflected by the 13th Finance Commission. Another significant feature

of the award of the 13th Finance Commission is the move towards performance linked

resource devolution and creating an incentive based system. The flip side of this is

that it would lead to a situation where the laggard states or local bodies would further

stay behind for not able to fulfill the stipulated conditions in accessing the overall

resource pie available for a particular purpose.

In comparison to the overall quantum of transfers either by way of tax

devolution or grants in aid, the resources earmarked for environmental purposes by

the Commission are only a fraction thereof. In addition to grants-in-aid of Rs. 15,000

crore for forests, renewable energy and the water sector, another Rs.6,721 crore state

specific grants as given in Table 4.2 could broadly, be considered for environmental

purposes. Keeping in view precarious condition of environmental resources in the

country, future Finance Commissions have to come out with a ‘Grand Bargain’ for the

environment. Despite such limitations, efforts of the 13th Finance Commission in

integrating environmental concerns in intergovernmental transfers are laudable.

To sum up, a critical evaluation of fiscal and environmental federalism in

India leads us to the observations as indicated at the next page:

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• Allocation of resources for core environmental considerations lacks prudent

norms in comparison to well established norms for socio-economic matters in

intergovernmental transfers.

• Multiplicity of agencies makes intergovernmental transfers cumbersome and

sometime work at cross-purposes.

• The formula based transfers are not targeted to offset fiscal disabilities of the

individual states and local bodies for ensuring even a minimum standard of

services.

• The current system of intergovernmental fiscal transfers lacks a fair and

transparent system of resource transfer from central government to the states

and to the local bodies charged with numerous environmental functions.

• There is no system of incentives and disincentives for conservation of natural

resources and accounting for environmental externalities in intergovernmental

fiscal transfers in India.

• Ecologically fragile regions such as mountains and islands having marine

conservation areas etc get ignored as no money had been earmarked for them

by the Finance Commissions.

In view of impending adverse consequences of climate change leading to

frequent and intense adverse climatic effects, states need to be prepared for adaptation

in various sectors. This aspect is extremely weak in the existing scheme of things in

the Indian federal system. Time is ripe to have the fiscal transfer policies taking into

account the ecological functions along with socio-economic functions in India. It is

expected that the inter-governmental fiscal transfers made after considering the

environment externalities (both positive and negative) would strengthen the

conservation measures on the one hand, and, on the other hand, horizontal payments

would check the free-riding of constituent units for using ecological services/space

over and above their entitlements based on the socio-economic parameters.

Invocation of “precautionary principle” in case of ecological services (ESs) is

also important as they operate on such large scale, complex and little understood ways

that most cannot be substituted by human endeavors or available technologies. Ill

planned developmental activities damage the flow of ESs on a large scale in a number

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of ways that in the long-term outweighs the tangible short-term economic benefits

from such activities. It is, therefore, relevant to evolve an inter-governmental fiscal

transfer system that is inclusive of environmental externalities.

It could, therefore, be concluded that fiscal federalism in India had worked

quite satisfactorily. However, there is a need to emphasize stability in federal relations

in general and in the system of transfers in particular while considering social,

economic and environmental issues in a comprehensive manner. In addition, it is

required that both the Finance and Planning Commissions should relook their

formulas used for the disbursement of funds in tandem by introducing environmental

services as well. The inclusion of an environmental performance indicator in fiscal

transfers would certainly motivate and compensate the states for their environmental

efforts. The thirteenth Finance Commission would do well also considering

environmental services while recommending grants to sub national governments. In

engineering sciences there is a theory of feedback system. A positive feedback

enhances manifold desirable outcomes while a negative feedback suppresses

undesirable outcomes. As a corollary, appropriate intergovernmental fiscal transfers

can provide the desired feedback mechanism for environmental externalities.

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Table 4.1: Environment Related Grants in Aid Recommended by the XII Finance Commission

State Environment Related Activity (Directly or indirectly)

Amount (Rs. Crores)

Haryana Water logging/salinity and declining water tables 100

Kerala Inland waterways and canals 225

Coastal zone management 175

Madhya Pradesh Development of urban areas 25

Maharashtra Coastal and eco-tourism 250

Manipur Loktak lake 1.15

Meghalaya Zoological park 30 Botanical garden 5

Mizoram Bamboo flowering 40 Orissa Consolidation and strengthening eco-

restoration work in the Chilika Lake 30

Sewerage system for Bhubaneswar 140

Punjab Stagnant agriculture 96

Rajasthan Indira Gandhi Nahar Pariyojana 300

Meeting drinking water scarcity in border and desert districts

150

Tamil Nadu Sea erosion and coastal area protection works 50

Uttar Pradesh Accelerating development of Bundelkhand and eastern regions

700

Development of urban areas 40

West Bengal Arsenic contamination of ground water 600 Problems relating to erosion by Ganga-Padma

river in Malda and Murshidabad districts 190

Development of Sundarbans Regions 100 Total 3257.5

(Source: Kumar and Managi, 2009) Table 4.2: STATE SPECIFIC GRANTS BY XIII FINANCE COMMISSION THOSE COULD BE CONSIDERED FOR ENVIRONMENTAL PURPOSES

State Purpose Amount (Rs crores)

Andhra Pradesh

1) Provision of drinking water in fluoride affected areas (Para 12.118)

2) Drinking water in inaccessible tribal areas (Para 12.118)

3) Strengthening State Pollution Control Board (Para 12.126)

350 200 20

Bihar 4) Interlinking of rivers (Para 12.149) 333

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Gujarat

5) Prevention of ingress of salinity (Para 12.160)

6) Address coastal erosion (Para 12.161) 7) Ground water recharge (Para 12.162) 8) Gir Lion Project (Para 12.167)

150 150 200 48

Haryana 9) Drinking water in south Haryana and Aravali (Para 12.170)

300

Himachal Pradesh 10) Augmentation of water supply schemes (Para 12.173)

11) Development of new parking lots, sewage, drainage and solid waste mgmt (Para 12.175)

150 50

Jammu & Kashmir 12) Protection and reinforcement of Tawi river (Para 12.180)

13) Wullar lake (Para 12.182)

25 120

Karnataka 14) Restoration of Tanks and Traditional water bodies (Para 12.196)

15) Drinking water (Para 12.197) 16) Upgrading and investment in solid

waste mgmt infrastructure of Bengaluru (Para 12.198 i)

350 300 200

Kerala 17) Inland waterways and coastal zone mgmt (Para 12.202)

18) Restoration of water bodies (Para 12.208)19) Kuttanad wetland ecosystem(Para12.209)

200 50 300

Maharastra 20) Anti-sea erosion measures (Para 2.218) 205 Meghalaya 21) Augmentation of Tura Water Supply

Schemes (Para 12.333) 50

Orissa 22) Echo restoration of Chilka lake (Para 12.254)

50

Punjab 23) Irrigation (Para 12.266) 200 Rajathan 24) Drinking water (Para 12.270)

25) Irrigation (Para 12.271) 500 300

Sikkim 26) Water security and Public Health Engineering (Para 12.277)

20

Tamil Nadu 27) Slum improvement (Para 12.282) 28) Coastal protection (Para 12.283) 29) Marine discharge project (Para 12.284) 30) Traditional water bodies (Para 12.285)

300 200 200 200

Tripura 31) Construction of Drainage system in Agartala (Para 12.292)

200

Uttar Pradesh 32) Drought proofing (Para 12.302 i) 200 Uttarakhand 33) Sewerage Scheme for Dehradun (Para

12.307) 150

West Bengal 34) Strengthening of river embankments (Para 12.318)

450

GRAND TOTAL 6,721 Source: Report of the XIII Finance Commission as compiled by the author