The fiscal tightrope for State governments
Kerala and Tamil Nadu are among the most socially and economically advanced States in India. Yet, the finances of both governments, like those of most
Kerala and Tamil Nadu are among the most socially and economically advanced States in India. Yet, the finances of both governments, like those of most other States, are under stress. The White Papers recently released by the two governments described their outstanding debt as alarming. State government debt is often vilified as the result of fiscal mismanagement. But it may, in fact, reflect a mismatch between development aspirations and the limited fiscal capacity of State governments. White Paper puts Kerala’s liabilities at ₹5.07-lakh crore, CM says fiscal structure under ‘serious’ strain The fiscal dilemma Debts build up over the years with deficits, which arise when the government’s expenditure overshoots its tax and other receipts. In India, while the power to raise taxes rests largely with the Union government, a larger share of overall government spending is borne by the State governments. A majority of the State government expenditure is on social sectors, such as health and education, and economic sectors, such as agriculture and irrigation, all of which have a direct impact on people’s lives and livelihoods. In Kerala, the high levels of State government spending on social sectors since the 1960s have been a central constituent of the public action driving social progress. Compared with the corresponding average for all Indian States, per capita State government social expenditure was higher in Kerala and Tamil Nadu (by 30% and 20%, respectively). In contrast, it was markedly lower in Bihar and Uttar Pradesh (by 35% and 40%) (for the period 2020-23, according to an analysis based on State Finances: A Study of Budgets, Reserve Bank of India).
White Paper addresses adverse impact of ‘revenue collapse’ on people of Tamil Nadu States meet their expenditures partly through their own revenues — which mainly include State Goods and Services Tax (SGST) and sales ta and through fiscal transfers, grants, and loans from the Union government. Kerala has a sufficiently good record of mobilising own-tax revenues, which, on a per capita basis, are 1.5 times the average for all Indian States and Union Territories. However, its share in the Union government’s tax devolution to States was 1.92%, lower than its 2.6% share of India’s population in 2023–24. The excess of expenditures over receipts has been met through market borrowings by the States, on which the States pay interest (Charts 1 and 2). Of the limited financial resources at its disposal, Kerala has been able to direct only 10% towards capital expenditure to enhance future production capabilities. The rest was spent on revenue, or day-to-day expenditure. Approximately a fifth of the State’s budget expenditure was on the salaries of government employees, mainly teachers, nurses, doctors, and police personnel. Pensions accounted for 15.3%, while interest on market borrowings accounted for 16.5% of the total budget expenditure (Chart 2). The investment challenge faced by Kerala Kerala is thus caught in a fiscal dilemma. If it tries to create more fiscal space by reducing revenue expenditures — cutting pensions, retrenching employees — it risks eroding its strengths in the social sector. At the same time, Kerala urgently requires large-scale, State-directed investments in infrastructure, higher education and research, and public transport, if it is to realise its potential in modern, knowledge-intensive economic sectors.
The BriefWire