States outstrip central government spending 1.7:1
While most analysts look at how the central government’s spending is going to rise, a recent report from Credit Suisse’s equity research team points out that all state governments together will be spending 65% more than the central government in FY16—in FY11, the spending was just 6% more. And given that state governments now have a lot more freedom in how they are going to be spending the money, this is a good thing. And contrary to what most believe, the bulk of the increase in state government spending has come from the states’ own resources, essentially higher VAT collections. Which is why it is odd that states should be apprehensive about implementing GST despite the good experience with increased buoyancy with VAT—between 2010 and 2013, for a total of 18 states, the number of sales tax assessees rose from 4.5 million to nearly 5.4 million. As a percent of GDP, the states own-tax revenues have risen from 5.6% in FY10 to a projected 6.6% in FY16. Apart from the buoyancy from GST, according to Credit Suisse, there is still a lot of potential in VAT collections since there are just 5.4 million sales tax assessees versus 58.5 million enterprises in the country—the fact that sales tax as a percent of GDP varies from 3% for West Bengal to 6.5% for Tamil Nadu also suggests there is a lot of scope for increased tax collections.
While much of the discussion on states tends to focus on how the money is badly spent, Credit Suisse has an interesting causality in terms of certain types of expenditure. States that have a bigger police force tend to have higher GDP, presumably because basic services like law and order are critical for greater investments. The same, however, cannot be said for other expenditure such as on teachers since, despite the increase from 3.9 million in 2010 to 4.7 million in 2014, education outcomes haven’t improved. Also, as a Kotak report on irrigation found, while states spent over R6.5 lakh crore on irrigation and flood-control over the last decade, irrigated area grew by just 1.3% per annum over FY1996-2011, and the bulk of the increase in irrigated area came from privately-owned tube wells. The flip side, of course, is that central government spending is not that much more efficient either.
The real killer, for both the Centre and the states, needless to say, will be the 7th Pay Commission whose report will be out in October—while states have their own Pay Commissions, they largely tend to match the Centre. States which employ roughly 57% of all those employed by government as a whole, could see a hike in wages by around R2 lakh crore—great news, of course, for consumer durable manufacturers—over the next two years. The burden will be less for the better-off states, but for a Punjab for instance, the salary increase can be as high as 11-12% of its total FY16 spending. How states deal with this will determine their future growth—some other spending will have to be sacrificed in the short-run—so additional tax mop-up will be critical.