Why we should be concerned about states’ fiscal health

By Vivek Singh & Karan Bhasin


Most discussions on public finance in India have tended to focus on central government finances. State government finances are now all the more relevant as the Fifteenth Finance Commission is due to submit its report.

It is important to analyse objectively the expenditure profile of states, in the context of the Fourteenth Finance Commission’s recommendation to increase devolution to the states from 32% of central taxes to 42%.

The argument in favour was the need to give greater control over development expenditures to state governments. The recommendation was accepted by the Centre as it increased the devolution to states. For example, Budget 2019 set aside Rs 8,09,133 crore to be shared with the states, up from Rs 3,37,808 crore in 2014-15, an increase of 139% in six years.

A lot of this increase was in untied funds that gave more freedom to states in terms of their allocation. Therefore, it would be opportune now to discuss the quality of expenditure by state governments.

According to data with the Reserve Bank of India, there are eight states — Andhra Pradesh, Haryana, Himachal Pradesh, Kerala, Maharashtra, Punjab, Rajasthan and Tamil Nadu — that are currently in a revenue-deficit position. Moreover, states such as Chhattisgarh, Assam, Tripura and Uttarakhand have also seen revenue deficits in the last few years.

Despite a significant increase in central allocation, the fiscal situation of states is a cause for concern. It is worth highlighting that this increase in revenue deficit came despite the states getting guaranteed tax revenue growth of 14% due to central government’s compensation for any loss in revenue due to the goods and services tax (GST).

A consequence of the increased devolution and GST compensation has been that states haven’t focused much on their own tax revenues. This is observable when one looks at the revenue share of the central taxpayers (assessees) in GST collections, which was 44.9% for the central government in 2018-19 and 45.3% in 2019-20 (April to December). In contrast, that for the states has come down from 55.1% in 2018-19 to 54.7% in 2019-20. While this dip may be marginal, it reveals the lack of adequate focus of states on improving compliance on GST-related matters.

Design on Development

Even as nominal growth has come down, the central government, despite severe fiscal constraints, has lived up to its commitments; the worsening of state finances is a serious cause for concern. An analysis of RBI data on the states’ expenditure, State Finances: A study of Budgets of 2019-20 (bit.do/fqV5N), shows that the share of development expenditure in total expenditure grew only marginally, from 65.5% in 2014-15 to 65.9% in 2017-18. Another important fact: social sector spending by the states grew 16.5% during 2010-15, which subsequently fell to 15.8% over the next five years.

At a more granular level, spending on education by the states especially took a hit, with the growth rate falling from 15.9% to 11.5% over the same period. The composition and quality of expenditure is extremely important from the point of view of our developmental objectives.

However, the revenue bounty has been squandered away by states in the form of expenditure on farm-loan waivers and other such subsidies. That is, states have used public resources that could have led to creation of human capital (or infrastructure) for the purpose of building their political capital.

Between 2017 and 2019, no less than seven states announced such waivers amounting to Rs 1.66 lakh crore. Farm loan waivers came at the cost of upgradation of rural infrastructure and extension of research and development services in agricultural practices. Another problematic area is of power discoms and of uneconomic power subsidies that have resulted in the power distribution sector facing a debt pile of over Rs 4 lakh crore.

It is worth highlighting that the Fourteenth Finance Commission recommended a post-devolution revenue deficit grant of Rs 1,94,821crore spread over five years, up significantly from the Rs 51,800 crore recommended by the Thirteenth Finance Commission. Despite this, states’ outstanding liabilities have ballooned over the years — to Rs 52,58,469 crore in 2019-20 from Rs 27,03,760 crore in 2014-15.

A consequence of the increase in borrowings is that it increases the costs of borrowing for the public sector, which absorbs a bulk of the domestic savings that could otherwise be utilised by the private sector for the purpose of financing investments.

Equal Responsibility

Following the recent amendments to the Fiscal Responsibility and Budget Management Act, the central government’s deficit and debt parameters have been explicitly defined while states have been allowed some flexibility.

Nevertheless, the onus of fiscal discipline does not lie solely on the Centre, and there is a need for states to realise their fiscal responsibility in order to bring better discipline on the fiscal front. State governments are equal stakeholders in India’s growth story and, therefore, they must work towards improving socioeconomic indicators by focusing on economic growth. Indeed, one hopes that the Fifteenth Finance Commission and its recommendations would help arrive at a consensus on several of these issues.

Singh is additional private secretary to the finance minister, and Bhasin is an independent economist. Views are personal