Central Government's Fiscal Capacity to Support States is Weakening Over Time

The larger issue has become aligned with the Central Government's own poor revenue collection capacity.

Union Finance Minister Nirmala Sitharaman. Image used for representation only. 

(Photo: PTI)

In a recent tweet released by the Ministry of Finance, it was announced that the Central Government disbursed Rs 1,18,280 crore as the third instalment of tax devolution to State Governments in June, against the normal monthly devolution of Rs 59,140 crore. Monthly figures of Centre-State disbursements may give misleading signals, given how in recent years, fiscal capacity, the discretion of the Central Government to collect and disburse promised tax revenue to States has remained volatile.

Our research team at InfoSphere, Centre for New Economics Studies (CNES), O P Jindal Global University, recently completed a study observing the Centre-State fiscal relationship more closely. The factsheet shared by the Ministry of Finance triggered a further investigation by our team studying the available data (from 2019 onwards) on the tax devolution-share from Centre to State Governments, drawn from government sources.

Some Key Observations

Figure 1 presents the overall net tax devolution proceeds (in Rs crores) from the year 2019 onwards transferred by the Central Government to all state-governments. These exclude union territories (UTs) from our list.

Figure 1: Tax Devolution from 2019-2024

Source: Author

Figure 2: Total Tax Devolution from Centre to State 

Source: Author

Figure 2 gives a macro-trend of tax-devolution from the centre on a year-to-year basis. This is a function of the accrued fiscal revenue capacity of the central government over the last few years. The pandemic year (2020-21) was tough for the fiscal purse of the government on a whole and as a result saw the lowest tax devolution level from Centre to the States.

This, in fact, made more States borrow extensively to cover healthcare, as well as other pandemic-induced costs from these ‘borrowed resources’. As a result, their fiscal deficit-debt levels were seen to be rising. As argued earlier, there has been increasing evidence of the central government arbitrarily squeezing the borrowing power of certain states, currently governed by opposition parties. Most State Finance Ministers have put this on the record.

Bihar, UP Get Most of Tax-devolution Share From Centre

Figures 3 and 4 below provide a ‘select’ look at the Centre to State tax devolution levels for a few opposition-governed vs. BJP-governed states.

Figure 3: Tax Devolution in Non-BJP Governed States

Source: Author

Figure 4: Tax Devolution in BJP Governed States

Source: Author 

States like Bihar and Uttar Pradesh still get most of the tax-devolution share from the Centre, largely because of their spatial, demographic, and socio-economic needs.

While states like Haryana, Punjab, Kerala have not seen critical growth in their tax-devolution share over the last five years. It is pertinent to note how each of these states have also seen their worst fiscal position scenario - accompanied with a decline in their Gross State Domestic Product (GSDP) levels over these years, which has been worsening since the pandemic. This warranted a more interventionist, counter-cyclical fiscal support from the Centre.

Also, states like Tamil Nadu, Chhattisgarh, Himachal Pradesh, Uttarakhand, have not seen any drastic shift in their net-devolution share as well, even though states like Tamil Nadu - given their strong GSDP position - contribute plenty to central government’s tax-revenue share.

A lack of vision in the medium to long term fiscal-policy approach, from the Central Government’s tax-based disbursements has therefore inadequately addressed this question: What role has the central government, which, by law and constitutional power, is assigned more fiscal capacity and discretion to raise and spend tax-based revenue resources, played in supporting states through spending?

3 Categorical Imperatives

What we broadly see in these trends are three broader, consequential categorical imperatives:

• The central government has merely maintained the status-quo when it comes to giving states ‘what they need’; they have not transferred more, or envisioned to transfer more tax revenue with the aim to enable a given state’s own welfare or growth needs and revenue requirements. The available data on transfers for both BJP-governed and non-BJP-governed states tell a tragic tale of a lopsided growth pattern evident across states, which is more of a continuum from the past, than realising change. This raises a more troubling question for the next point.

• What this says is that the central government under the Modi administration (since the last few years, read 2019 onwards from our data) has increasingly seen a gradual erosion in its fiscal capacity to support states, which need more revenue for growth and welfare requirements. This fact subsequently has little to do with the political parties governing the states, but over time, the larger issue has become more aligned to the central government’s own poor revenue collection capacity (that is, failing to collect the revenue that the central government projects in its own Union Budget estimate). 

• The poor quality of government data makes it extremely difficult for anyone to effectively analyse the potential gains or losses made from the allocated tax-devolution proceeds shared by the central government for States over the last few years. The current administration, it seems, has done everything in its power to not even collect ‘good’ data which can help recognise fiscal challenges/potentials, to strengthen policy for a long term good.

A Fiscally Weak Government

This, is a marked sign of a ‘fiscally weak’ and ‘insecure’ government, that is content to project empty riddles of economic ‘optimism’ built merely around rhetorical hope, pasting ‘India Shining data’ on relative comparisons of ‘good growth performance’ (made with countries industrially far more advanced and at a higher order of development), but underneath its own core, India suffers from a ‘silent fiscal crisis’ and under ‘poor macroeconomic fundamentals’.

These indicate an economy moving towards a state of permanent decline, sourced from structural weakness, in which any central government will be able to do (fiscally) very little for states even if they want to do more (assuming there is a willingness to do so).

(Deepanshu Mohan is Professor of Economics and Director, Centre for New Economics Studies (CNES), Jindal School of Liberal Arts and Humanities, OP Jindal Global University. This is an opinion article and the views expressed are the author’s own. The Quint neither endorses nor is responsible for them.)