Editorial of the Day: A Macro view of the Fiscal Health of States (The Hindu)

Context: The article is discussing the fiscal situation of the states in India and the importance of understanding their finances for drawing evidence-based inferences on the overall fiscal situation of the country. It highlights key data from individual state budgets for the fiscal year 2023-24. The article mentions that the states in India mobilise over a third of the total revenue, account for 60% of combined government expenditure, and have a share in government borrowing of around 40%. These figures indicate the significant role played by the states in the fiscal operations of the country. The article also emphasizes the need for a comprehensive revenue deficit reduction framework to improve the fiscal health of the states. By implementing measures to reduce these deficits, the states can strengthen their financial positions.

Background

Centre-State Financial Relations:

Article 268 to 293 of the constitution deals with Centre-State Financial Relations.

• The Union government (Parliament) has the exclusive authority to tax subjects mentioned in the Union list.
• State legislatures have the power to tax subjects mentioned in the State list.
• Subjects mentioned in the concurrent list can be taxed by both the state and the Union.
• The residuary power to tax belongs to the Parliament.

Constitutional Restriction on State’s Taxation Power:

• The state legislatures have the power to tax occupations, trades, callings, and professions. However, the total compensation for such taxation should not exceed Rs 2500 per year.
• States can impose taxes on the sale or purchase of products, except for newspapers. However, certain restrictions apply, such as exempting sales and purchases made outside the state, during import or export, or during interstate trade or commerce.
• State taxes cannot be imposed on electricity used by or sold to the central government or for railway purposes, unless approved by the President.

Distribution of Tax Revenues: (Article 268- 270)

• Taxes levied by the Centre but collected and used by the states are deposited in the state’s consolidated fund. This includes excise tax, stamp duty, and taxes on goods purchased or sold in interstate commerce.
• Taxes other than those mentioned above, surcharges, and cess are divided between the Centre and the states based on the President’s decision, following recommendations from the Finance Commission.

Distribution of Non-Tax Revenues:

• The Centre’s primary non-tax revenue sources include postal and telegraph services, railways, banking, broadcasting, coinage and currency, central public sector enterprises, escheat, and lapse.
• The states’ non-tax revenue sources include irrigation, forests, fisheries, state public sector enterprises, escheat, and lapse.

Grants-in-Aid to the States:

• The Centre provides grants-in-aid to the states, which can be either statutory or discretionary (Art 275).
• Statutory grants are provided based on specific requirements and Finance Commission recommendations.
• Discretionary grants (Article 282) can be given by the Centre or states for any public purpose.

Goods and Services Tax Council:

• The Goods and Services Tax (GST) Council was established (Article 279) to facilitate cooperation and coordination between the Centre and the states for the efficient administration of GST.
• The Council makes recommendations on matters such as merging taxes into GST, goods and services subject to GST, model GST laws, rates, threshold limits, and special rates during natural calamities.

These financial relations aim to maintain a balance between the Centre and the states, ensuring fiscal stability and cooperative decision-making in matters of taxation and revenue distribution.

Decoding the Editorial

The article suggests that there has been a significant improvement in the fiscal situation of both the central government (Union) and the states in India after the COVID-19 pandemic.

Key Observations:

Central and State Finances:

• The general government deficit and debt, which increased during the pandemic, have started to decrease.
• At the Union level, the fiscal deficit, which refers to the excess of government expenditure over its revenue, has declined from 9.1% of GDP in 2020-21 to 5.9% in the budget estimate (BE) for 2023-24.
• Similarly, the fiscal deficit for all states combined was 4.1% of GDP in 2020-21 and decreased to 3.24% of GDP in 2022-23 (revised estimate or RE). For the major states, it is expected to further reduce to 2.9% of GDP in 2023-24 (BE).

Data on Finances:

• There is a lack of readily available consolidated data on general government finances due to the absence of aggregation of individual state budget data.
• The Reserve Bank of India (RBI) publishes an annual study on state finances, but it becomes available only in the second half of the fiscal year.
• To address this, the analysis in the article is based on data collated from the individual budgets of 17 major states, which account for over 90% of the combined spending of all states.
• The fiscal issues emerging from these budgets are considered representative of the state finances in India.
• The analysis indicates that these states have successfully managed to contain their fiscal deficits.

Factors for Fiscal Consolidation:

The article highlights several factors contributing to the fiscal consolidation.

• Firstly, despite a significant contraction in revenues during the peak of the COVID-19 pandemic, states have demonstrated fiscal prudence.
• Secondly, handling the emergency provision for health spending and livelihood required coordination between the central government and states.
• Thirdly, states were able to reprioritize expenditure and quickly contain the fiscal deficit.
• Fourthly, the reduction in fiscal deficit is attributed to adjustments on the expenditure side, improved Goods and Services Tax (GST) collection, and higher tax devolution from the central government.
• Finally, non-GST revenues in most states are also showing signs of recovery after the pandemic.

This indicates that the fiscal situation of both the central government and states in India has improved after the COVID-19 pandemic. The fiscal deficits have decreased, and states have demonstrated fiscal prudence and effective management of their budgets, despite the challenging circumstances.

Fiscal Challenges and Ways to Address them:

The article highlights significant fiscal challenges that need to be addressed in the short to medium term, with the most critical challenge being the containment of revenue deficits in the states.

• While there has been a reduction in fiscal deficits, the corresponding reduction in revenue deficits has not been achieved.
• Out of the 17 major states considered, 13 states have deficits in the revenue account in the budget estimate (BE) for 2023-24.
• Among these, seven states (Andhra Pradesh, Haryana, Kerala, Punjab, Rajasthan, Tamil Nadu, and West Bengal) have fiscal deficits primarily driven by revenue deficits. These states also have high debt to Gross State Domestic Product (GSDP) ratios.
• The presence of a revenue deficit does not necessarily indicate fiscal profligacy, and the pressure on revenue expenditure was particularly high during the COVID-19 pandemic. However, the increasing revenue deficits have long-term fiscal implications, and it is important to correct this imbalance in the revenue account.

Assessment of Finance Commissions:

Additionally, an assessment of successive Finance Commissions has identified Kerala, Punjab, and West Bengal as fiscally stressed states, and the number of fiscally stressed states has now increased to seven.

• The combined fiscal deficit, combined revenue deficit, and debt ratio indicate that the fiscal indicators of these states are higher compared to the all-state averages and the recommended debt ratio by the Finance Commission for all states in the year 2023-24.
• These states collectively contribute around 40% to India’s GDP. Therefore, ensuring fiscal stability in state finances is crucial for promoting higher state-specific growth.
• Moreover, these states have been significant drivers of public capital expenditures and attractive investment destinations for private investors.

Measures:

The article suggests several measures that can be considered to consolidate revenue deficits.

• One approach is to link interest-free loans provided by the central government to states with a reduction in revenue deficits.
  • By doing so, the possibility of states substituting their own capital spending with borrowed resources and diverting funds towards revenue expenditure can be eliminated.
• Implementing a defined time path for reducing revenue deficits, along with a credible fiscal adjustment plan, would help restore fiscal balance and improve the quality of expenditure.
• The article also proposes the consideration of forward-looking performance incentive grants as a means to incentivize states to reduce their revenue deficits.
• It suggests exploring different approaches provided by previous Finance Commissions to determine the framework for the incentive structure.

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