Column: Emerging trends in state finances

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Published: May 3, 2016 5:28:58 AM

Restructuring of centrally-sponsored schemes needs to be carefully examined

Much of the mainstream discussion on Indian public finances is confined to the finances of the Union government, very little attention is paid to state finances and their impact on sustainable public finances in the country and spending on social and physical infrastructure that is essential for accelerating growth. Most discussions and evaluations on the Union budget assume that the government is supposed to do everything ranging from water and sanitation, agricultural development, health and education, safety and security of people. The fact is that the Constitution assigns the states a predominant role in the provision of social services and co-equal role with the Union government in the provision of economic services to the states. Indeed, if the defence of the country is the responsibility of the Union government, maintaining law and order falls squarely in the states’ domain. States raise 37.3 % of the total revenues and implement 60% of the total expenditures incurred and yet, the discussion on state finances is generally muted.

Available information shows that, by and large, the states have adhered to the fiscal targets set out in their medium term fiscal policy (MTFP) since FY05, when all the states except Mizoram and West Bengal enacted the fiscal responsibility legislation. Based on the recommendations of the 12th Finance Commission, the states enacted the fiscal responsibility legislations and adhered to the MTFP targets specified in them to phase out the revenue deficits and contain their fiscal deficits at less than 3% of GSDP. The two states too enacted the legislations in 2009 after the 13th Finance Commission renewed the incentives to them. The trend in fiscal consolidation at the state level continued until FY14 when the states’ aggregate fiscal deficit was brought down to 2.2% of GDP and the revenue deficit was virtually phased out. In the last two years, the deficit position seems to have weakened in keeping with the electoral budget cycle. The fiscal deficit increased to 2.9% of GDP in FY15 and was slightly lower in FY16. States’ budget estimates for FY17, project the fiscal deficit at 2.6% which is marginally higher than the target of 2.4% (equivalent of 3% of GSDP). Three important facts must be noted in this context. Unlike the Union government which can borrow without any restrictions, the states’ borrowing limits are set by the central government under Article 293. Second, the states have a marginal revenue surplus which implies that the entire borrowing is used to finance their capital expenditures. Finally, the budget estimates often can be misleading. Past experience shows that during the course of the year, the states tend to contain their deficits by compressing expenditures. Of course, there were exceptions, particularly in the case of Kerala, Punjab and West Bengal, but even they have tried to substantially correct their fiscal stance.

As mentioned above, despite the significant increase in tax devolution subsequent to the recommendation of the Fourteenth Finance Commission (FFC), the finances of the state governments have come under pressure in the last two years. There are four important reasons for this. First, the increase in tax devolution was matched by the Union government compressing the grants for centrally sponsored schemes so the aggregate transfers have not shown any appreciable increase. Second, while the tax revenues have shown a significant mopping up of additional revenues by increasing excise duties on petroleum products in the wake of declining crude oil prices and raising of service tax during FY16, the states were denied the benefit of higher tax devolution as most of the additional resource mobilisation measures were by way of levying cesses and surcharges which are not shareable with the states. Thus, while the revised estimate of revenue accruing to the Union government in FY16 was higher than the budget estimate by R27,666 crore, the amount devolved to the states in the revised estimate was lower by R17,765 crore. Third, decline in the price of motor spirit and high speed diesel has resulted in lower tax revenue collections from these commodities. As most states get over 35% of their sales tax revenues from these products, this has had a dampening effect on the buoyancy of states’ tax revenues. Finally, the increase in states’ fiscal deficit, in part, reflects the impact of the electoral budget cycle and it remains to be seen to what extent the slippage has occurred on this account when the actual figures are finalised.

From the perspective of fiscal sustainability and developmental outlay, six important changes must be noted. First, the sharp increase in the tax devolution from 32% of the divisible pool to 42% based on the recommendation of the FFC has substantially changed the fiscal balance between the Union and states. Although this has not led to increase in the overall transfers to the states, as the Union government has correspondingly reduced the grants under centrally sponsored schemes, the increase in untied transfers has led to greater fiscal autonomy. It is therefore important to analyse the allocation of funds to social sectors such as education and healthcare as well as capital expenditures. Second, restructuring, consolidation and compression of centrally sponsored schemes has had its impact on the allocations between various sectors as well as between different states and this needs to be carefully examined. Third, the recommendation of the FFC that the states with low interest payment to revenue ratio and those with low debt to GSDP ratios could be given additional borrowing space could increase the aggregate fiscal deficit, though its impact is likely to be marginal. Fourth, the introduction of UDAY wherein the states are required to take over 70% of the outstanding liabilities of the discoms has increased the debt burden of the states. Although this is not counted for fiscal targets, the interest burden on the debt taken over could be substantial and would add to the fiscal pressures of the states. Fifth, the buoyant tax revenues at the state level until FY15 were mainly due to increase in the prices of diesel and motor spirit. Ad valorem levies at a minimum of 20% on these products by the states increased their revenues substantially. This benefit will not be available in the coming year. Finally, with the Union government revising the pay scales of its employees, there will be pressure on many of the states to follow suit and that is likely to increase the expenditure of the states. The report provides insights on many of these issues and hopefully, the readers will find it useful.

The author is emeritus professor, NIPFP and senior adviser, Deloitte Touche Tohmatsu India and chief

economic adviser, Brickwork Ratings Views are personal

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