Indian states have little money. They need help – analysis
Prime Minister Narendra Modi’s announcement of the Rs 20 lakh crore Atmanirbhar Bharat Abhiyan (Self-Sufficient Campaign of India) package left many in trouble with fiscal mathematics: where would resources come from and how would they be structured? In the past five days, details have emerged; This includes increasing allocations to the Mahatma Gandhi National Rural Employment Guarantee Plan (MGNREGS), alleviating the concerns of micro, small and medium-sized enterprises, ending the coal monopoly and guaranteeing credit to farmers. The last section also focused on a very necessary aspect: addressing the fiscal health of the states.
We analyzed the income and expenditures of 17 states to determine the state of their finances before the outbreak of coronavirus disease (Covid-19) and to assess their ability to cope with the crisis. Our findings suggest that recent changes in India’s tax architecture, including the goods and services tax (GST) regime and increased state actions for centrally sponsored schemes (CSS), had placed state finances in a precarious position, even before the crisis.
State dependence on the Center for revenue has increased, and the share of revenue from its own sources decreased from 55% in 2014-15 to 50.5% in 2020-21. While part of this is inherent in India’s tax structure, where states spend the most and the Center controls bags, the situation has been exacerbated by the introduction of the GST. With a few exceptions, such as petroleum products, property tax, and excise duties on alcohol, indirect taxes have been largely subsumed under the GST regime, eroding states’ ability to collect their own income.
Generally, part of this imbalance is corrected by freeing the states from tax refunds. In addition, to compensate for the loss of revenue due to the change in the tax system, the GST regime includes a provision in which if the tax collection falls below a growth rate of 14% for the state GST, the Center disburses a GST compensation.
Our analysis, however, finds that real taxes transferred to the states have remained consistently lower than those projected by the 14th Finance Commission (FC), a deficit of around Rs 6.84 lakh crore between 2015-2020. This has been driven by an increase in the share of gross revenues from ceases and surcharges imposed by the Center, which are not shared with the states, from 2.3% in the early 1980s to 15% in the recent period according to the Reserve Bank of India, and a deficit in real tax collection. While the Center released Rs 46,038 crore in April according to the original budget, subsequent deliveries will tell us whether the deficit trend will continue.
Adding to state problems is the significant divergence in past periods between the amount of GST compensation owed and the actual payments made, even for states like Uttar Pradesh, Bihar and Jharkhand that need more fiscal support. Even before Covid-19’s success, 11 states estimated an income growth rate below the estimated level of 14%, implying that higher amounts will be due as GST compensation. Since most of the states’ GST comes from products like electronics, fashion and entertainment, all of which have been affected by the pandemic, these revenues are likely to decline further.
The Center’s second main source of income is the CSS, which is intended to guarantee a minimum standard of public service provision throughout the country. Although overall funding through CSS has decreased for many states following the recommendations of the 14th FC, they still make up a significant portion of revenue.
However, CSS tends to be unpredictable, and versions are determined by meeting certain conditions. In 2019-20, the total deficit between the estimated budgets and the revised estimates was Rs 14,794 million. One of those conditions is the state requirement to put a portion of their own funds into CSS. In October 2015, this share increased from 15% -25% to a maximum of 50% for various schemes, slowing down states’ fiscal flexibility by limiting revenues to CSS. The Center’s recent circular, which clarifies that it will not reduce CSS funding, but will not decrease state involvement, will be of little comfort to states at a time when the greatest need is flexibility to meet local needs.
The spending analysis shows that in 2020-21, states expected only about 75% of their total spending to be covered by revenue, with the rest coming from other sources, such as external loans. This is even after many states had anticipated lower spending on health and the social sector.
While spending is likely to increase in response to the pandemic, with more than a third of funds already committed to wages, pensions, and interest payments, finding additional resources will be difficult. A 60% increase in the limits for short-term loans is unlikely to meet long-term loan requirements. Sunday’s announcement of the increase of the state debt limits from 3% of the GSDP to 5%, resulting in an additional Rs 4.28 lakh crore also comes with reform conditions and only 0.5%, or Rs 2,140 million rupees, as unrelated, that states can spend as needed.
There is no doubt that the pandemic and the blockade have stopped various aspects of socio-economic life. The slowdown in production and consumption is expected to have medium and long-term repercussions for the economy, in terms of its capacities to collect income and expenses. The state’s ability to respond effectively will be determined by how quickly it can move away from a business model as usual to what some have called wartime economics. It remains to be seen whether the measures extended by the Center and RBI will be adequate for states to overcome the crisis.
Avani Kapur is a member of the Policy Research Center and director of the Accountability Initiative (AI).
Udit Ranjan is a Senior Research Associate, AI.
(This article is based on an AI working paper and is co-authored with Vastav Irava and Sharad Pandey)
The opinions expressed are personal.