As the year of 2024 ends, the bloating asymmetric, unequal state of India’s political economy landscape and the state-wise fiscal development scenario remains polarised by a growing debate around the need to balance the nation’s growth and welfare aspirations targeting all citizenry with questions of both, state capacity and political will.
The ‘bad freebie’ vs. ‘good welfare’ discourse has seen rivers of ink being spilled over across columns, debates amongst economists, policy observers, and social scientists commenting on either side of the debate since the time Prime Minister Narendra Modi made the ‘revdi’ remark as a veiled attack at the “freebie-centered electoral politics” of the Aam Aadmi Party (AAP) a few years ago.
AAP now is taking the Bharatiya Janata Party (BJP) head on in the upcoming Delhi polls, which is likely to be a tight contest between the two competing parties (with differed ideologies).
Even though the AAP’s Delhi chief minister Arvind Kejriwal teared into the Prime Minister’s remarks a few years ago, and this author had already commented on the issue then, one interesting linkage remains to be pursued: examining the link between state-accrued public debt and its ability to provide better/worse welfare services (or public goods).
One is yet to find a comprehensive analysis exploring this link especially in context to the debate that has exploded over the last few years. Here is an attempt to understand and examine the issue more closely.
How do states perform on fiscal?
To put into context, it must be realised that during most of the last three to four years, despite a pandemic wreaking havoc on almost all states’ fiscal positions, exacerbating the public debt levels of states and at the Union, the Modi government offered little direct fiscal support for most affected state governments to meet their financial needs. All talk on cooperative, competitive federalism has rung aloud amidst a trend of centralising political power at the cost of essential fiscal distribution of resources, a duty of the Union, which has been extensively politicised for party gains.
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States, even during the last few years, are expected to incur a higher proportion of healthcare, education and welfare costs. During the pandemic, most state budgets, due to swelling healthcare costs, were stretching thin and as a result accumulated higher deficits. The Union government did step in to provide support for direct procurement of vaccines, but a lot of the help that came in was too little, too late.
During most of the pandemic-induced lockdown, when the vulnerable sections were devastated by poverty and suffering, most of the financial assistance for states came in the form of liquidity support with the opportunity to borrow through the RBI or the Union/Centre.
Many states like Kerala, Tamil Nadu, West Bengal, Telangana, and others (mostly non-BJP ruled states) remained skeptical of the Union government’s actions and tried to avoid borrowing excessively to meet their increased expenses. The recently reported loss in state autonomy for managing its fiscal resources has made more of such states cautious and anxious about their ability (and agency) to manage their own budgets and borrowings.
(Source: Author Calculations from Handbook of Statistics on Indian Economy (RBI) and Union Budget Documents, 2012-24)
The state-accrued public debt issue needs to be read from each state’s fiscal context and spending-needs perspective. Indian States also have limited sources to generate revenue.
Revenue recovery: Progress with underlying challenges
The RBI’s 2024 State Finance Report reveals a quasi-federal framework in which state revenues have shown a remarkable post-pandemic recovery. However, this positive headline only tells part of the story.
Behind this recovery lies a web of systematic challenges in critical sectors, creating a complex fiscal landscape that demands careful attention and caution moving forward.
In 2023-24, state GST (SGST) collections, a primary source of own tax revenue, climbed to 2.9% of GDP, a significant leap from the pandemic-induced low of 2.3% in 2020-21. This revival is a positive indicator of the improving economic activity and the efficacy of tax administration reforms such as mandatory e-invoicing and AI-based analytics to curb leakages. However, their scalability across all states remains debatable and uncertain, particularly in those with weaker administrative capacities.
Beneath this revival there lies a stark disparity. States like Odisha and Chhattisgarh now benefit from additional revenue streams enabled by the Supreme Court’s 2024 ruling on mineral taxation. In contrast, states such as Bihar and Uttar Pradesh rely heavily on consumption-driven SGST growth. This highlights the urgent need for states to break free from their reliance on traditional revenue streams and ignite growth in the industrial and service sectors. Without bold structural reforms, their fiscal stability risks being precarious.
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Adding to these challenges, the central transfers which acts as a lifeline for many states has declined sharply, from 6.4% of GDP in 2018-19 to 5.5% in 2023-24. The cessation of GST compensation grants has left many states scrambling for alternative revenue streams. For fiscally weaker states, this decline in central support demands either a cut in social expenditure or increased borrowing, which leads to more debt dependency.
Cracks beneath the surface: Fiscal deficits and dependencies
The spectre of growing fiscal deficits looms large, with over 18 states surpassing the 3% GSDP threshold in 2023-24. Government debt to GDP levels have also been exacerbating (analysed here).
Chronic revenue deficits in Arunachal Pradesh and Punjab reflect entrenched inefficiencies in expenditure management and limited revenue resilience. These states often rely on borrowing to even meet their operational expenses, a short-term fix that exacerbates long-term fiscal instability.
Debt sustainability presents another looming challenge. States like Punjab, where debt-to-GSDP ratios exceed 40%, face significant risks. High debt levels not only strain future budgets but also deter investments in critical sectors such as infrastructure, health, and education.
A robust debt management framework, coupled with disciplined fiscal planning, is essential to mitigate these risks.
Power distribution companies (discoms) continue to further burden state finances. Despite reforms like UDAY, their losses doubled to Rs 62,111 crore in 2022-23 primarily driven by 19 states running losses in state-owned private distribution like Uttar Pradesh, Maharashtra, Karnataka and Punjab.
Little attempt has been made to work on coal prices and systemic inefficiencies at times dangerously close to incompetency leading from multiple different states. Owing to the irregularities there is an urgent need for tariff reforms and modernisation initiatives such as smart metering under the Revamped Distribution Sector Scheme (RDSS).
(Source: RBI Study of State Finances 2023-24)
Unpacking central grants: equity, efficiency and challenges
The allocation of Centrally Sponsored Schemes (CSS), which make up over 20% of central transfers, remains contentious. While supposedly aimed at equalising developmental outcomes, inconsistencies in allocation formulas never seems to end.
For example, richer states like Telangana and Tamil Nadu receive over Rs 2,500 per capita in grants, while poorer states like Bihar and Uttar Pradesh average only Rs 1,600. Such inconsistency requires a shift toward needs-based allocation mechanisms, particularly for regions with weaker institutional capacities.
Moreover, tied grants often impose tiring compliance requirements, such as audited accounts or property tax growth targets, which many poorer states struggle to meet. This not only hampers their ability to access critical funds but also undermines the broader goal of balanced regional development. United transfers, allowing states greater discretion, could serve as a more effective alternative for empowering state-level decision-making.
The absence of GST compensation grants has further intensified fiscal pressures. While the levy on goods such as tobacco and coal remain until 2026 to repay central borrowings, the lack of direct compensation leaves states vulnerable. A balanced cess-sharing framework could provide much-needed relief, ensuring that fiscally weaker states are not disproportionately affected.
Towards fiscal sustainability
To navigate these challenges, states must adopt a multi-pronged approach to fiscal resilience. Rationalising subsidies is an urgent priority. Punjab, for instance, spends 24% of its revenue receipts on subsidies, primarily for free electricity. Despite its political appeal, such measures sabotage fiscal health. Targeted subsidies, implemented via means-testing or direct benefit transfers, could free up resources for productive and more practical investments.
Asset monetisation offers another avenue for revenue enhancement. States like Odisha have demonstrated the potential of leveraging natural resources effectively, with non-tax revenues at 6.3% of GSDP. Expanding this approach to include public infrastructure assets, such as industrial estates and road networks, could generate significant funds. However, ensuring transparency and mitigating risks like undervaluation remain critical to its success.
Reforming the power sector is another non-negotiable area. Smart metering and addressing tariff inefficiencies are vital to reducing discom losses. Diversifying energy sources and pivoting away from dependence on volatile coal markets will further strengthen the sector’s financial sustainability.
Finally, recalibrating fiscal federalism is imperative. Increasing united transfers and revising tax devolution formulas can empower states to prioritise local development needs. The 16th Finance Commission’s deliberations offer a timely opportunity to address these vertical imbalances and lay the foundation for a more equitable fiscal framework.
Welfare performance of states in terms of ‘Access Equality’
Our Centre for New Economics Studies (CNES’) Access (In)Equality Index (AEI) in 2024 observed how states like Delhi (despite its unique multi-party governance architecture), West Bengal, Kerala (or even Goa and Sikkim) perform better compared to states like UP, Bihar and Madhya Pradesh, when it comes to being measured for securing access to basic social, economic services.
Securing easier access to basic socio-economic goods i.e. education, healthcare, social security, financial security, basic amenities is essentially part of an elected state government’s core responsibility to its citizenry.
While every state government may have different fiscal capabilities to meet the social, economic needs of its residential population at the time, what cannot be discounted is the fact that the ‘fiscal priority mapping’ of any state government (a BJP or non-BJP one) must be closely linked to welfare enhancing measures.
For context to AEI, in the methodological design of the multidimensional Access (In)Equality Index (AEI), we measured overall access, using geometric mean in order to ensure partial compensability, i.e. poor performance in one sub-index is not fully compensated by good performance in another.
It also balances the uneven performance in the dimensions and encourages improvements in the weaker dimensions. Other prominent indices like the human development index and sustainable society index use the geometric mean for aggregation as well.
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Based on the score range of 0.67-0.23, states are grouped into three categories – ‘Aspirants’ (below 0.33), ‘Achievers’ (0.42-0.33) and ‘Front Runners’ (above 0.42). Bihar, Uttar Pradesh, Jharkhand, Assam, Odisha and Madhya Pradesh fall under ‘Aspirants’, requiring sustained efforts to improve ‘access’ to basic socio-economic opportunities (across all identified pillars).
States like Maharashtra, Arunachal Pradesh, Gujarat, Uttarakhand, Chhattisgarh, Rajasthan, Tripura, West Bengal, Manipur and Meghalaya are categorised as ‘Achievers’. These states have good provisions of access to (socio-economic) opportunities and must sustain their efforts to advance to the next category.
Lastly, states such as Goa, Sikkim, Tamil Nadu, Kerala, Himachal Pradesh, Telangana, Punjab, Mizoram and Karnataka are observed as ‘Front Runners’ in ensuring better access to basic socio-economic opportunities for their respective state-populations.
It is worth (re)iterating the close, correlative link drawn between state-debt levels and their AEI performance for welfare-based comparison.
States like Kerala, Punjab, Telangana, despite their high public debt have ensured better access to basic social and economic services to their state populations and have done well across most AEI pillars consistently. This has helped their respective state populations to also do well in creating high productivity across the nation.
At the same time, states like Bihar, Uttar Pradesh, Madhya Pradesh, Assam and Jharkhand (note how 4 of these 5 are BJP-run states) perform the lowest across most AEI pillars and are ranked the lowest in most ‘access’ measuring indicators.
Closing Argument
Recent cases of letters and points of contention raised/exchanged between state finance ministers (of Kerala, West Bengal, Telangana and Tamil Nadu) and Union finance ministry show how the Modi government is arbitrarily squeezing non-BJP states from exercising their fiscal autonomy.
In managing the swelling fiscal deficit and public debt levels (including of fiscally weak states), the public expenditure composition and fiscal priorities must be more clearly understood, due to differed constitutional assignment of functions for the Union and state governments. Most redistributive expenditures – critical for welfare outcomes – are in the functional domain of states.
Any contraction of such expenditure at the state level due to coercive actions of the Union government or due to high state accrued public debt levels can have adverse distributional consequences, with a regression that can already be observed in performance outcomes state-level performance on access to education, healthcare, social security, particularly for the vulnerable and marginalized sections.
Welfare driven expenditure needs are not part of ‘revdi’ politics but more about securing a government’s basic responsibility to its people and the larger citizenry.
State governments (irrespective of their party affiliation) need all the support they can get at this point to either borrow ‘more freely’ under a mutually agreed fiscal roadmap for their developmental needs or be otherwise supported to manage their finances on their own, or through borrowing financed support offered by the Union/Centre.
In either of the scenarios, fiscal cooperation and transparent functioning is vital for protecting state’s fiscal space and enhancing macroeconomic stability. There is no room for an ‘ad hoc’, ‘arbitrary’ decision-making mechanism, nor for selective partisan constitutional interpretations, which might trigger more direct confrontations between state governments and the Ministry of Finance going forward.
Aryan Govindakrishnan, senior research assistant, Centre for New Economics Studies (CNES), contributed to the research for this column.
Deepanshu Mohan is associate professor of Economics and director, CNES, Jindal School of Liberal Arts and Humanities, O.P. Jindal Global University.
