Macro-Economics

Project Report
Trends in State Finances
Executive Summary
The salient features of the Study are as follows:
• The consolidated revenue balance of the States, after remaining surplus for three consecutive years, is
budgeted to turn into a deficit of 0.5 per cent of GDP in 2009-10 (BE).
• Reflecting the deterioration in revenue account of the State governments, GFD as percentage to GDP is
budgeted to be higher at 3.2 per cent in 2009-10 as compared with 2.6 per cent in 2008-09 (RE) and 1.5 per
cent in 2007-08 (Accounts).
• The debt-GDP ratio of State governments declined to 26.2 per cent in 2008-09 (RE) from the peak level of
32.8 per cent as on March 2004.
• States have started implementing the recommendations of the Sixth Central/States’ Own Pay
Commissions. Although, the States’ consolidated revenue surplus declined during 2008-09 (RE), it is widely
perceived that States are in a better position to absorb the impact of implementation of Pay Commission
awards.
• Compression in consolidated expenditure of State governments can be observed during 2005-10 period
mainly on account of some rationalisation of revenue expenditure during the fiscal responsibility legislation
(FRL) period. This is evident from decline in RE-GDP ratio from an average level of 13.3 per cent during
2000-05 to 12.4 per cent during 2005-10.
• The Study discusses various contemporary issues relating to finances of State governments, viz., revenue
augmentation, quality of expenditure, strengthening of rule based framework, fiscal transparency, surplus
cash balances, impact of stimulus programmes and implementation of awards of the Pay Commissions.
List of Abbreviations
AD - Aggregate Disbursements
BE - Budget Estimates
BIFR - Bureau for Industrial Finance and
Restructuring
BOT - Build Operate Transfer
CAG - Comptroller and Auditor General of
India
CARG - Compound Annual Rate of Growth
CE - Capital Expenditure
CR - Capital Receipts
CRR - Cash Reserve Ratio
CST - Central Sales Tax
CT - Current Transfers
Dev. Exp. - Developmental Expenditure
DT - Direct Taxes
EFC - Eleventh Finance Commission
EME - Emerging Market Economies
ES - Economic Services
FIs - Financial Institutions
FRL - Fiscal Responsibility Legislation
GDP - Gross Domestic Product
GFD - Gross Fiscal Deficit
GFD Exp. - Gross Fiscal Deficit Expenditure
GS - General Services
GSDP - Gross State Domestic Product
IP - Interest Payments
IR - Interest Receipts
LFC - Loans from Centre
MoF - Ministry of Finance
NIRE - Non-Interest Revenue Expenditure
[Link].- Non-Developmental Expenditure
ONTR - Own Non-Tax Revenue
OR - Own Revenue
OTR - Own Tax Revenue
PC - Planning Commission
PCCO - Per Capita Capital Outlay
PD - Primary Deficit
PRB - Primary Revenue Balance
PRS - Primary Revenue Surplus
PSUs - Public Sector Undertakings
RBI - Reserve Bank of India
RD - Revenue Deficit/Rural Development
RE - Revised Estimates
Rev. Exp. - Revenue Expenditure
RR - Revenue Receipts
SGE - State Government Expenditure
TE - Total Expenditure
ThFC - Thirteenth Finance Commission
TwFC - Twelfth Finance Commission
TR - Tax Revenue
VAT - Value Added Tax
Acknowledgements
 List of Tables

Table 1- the deficit indicators of the state governments of India

Table 2- Revenue receipts of the state Governments

List of Figures

Fig-1 - Deficits as a whole

Fig-2 - Revenue deficit/Surplus of states of India
Fig-3 - Gross Fiscal Deficit/Surplus of states
Fig-4 - Own Tax revenue of States
Fig-5 - Own Non tax revenues of states
Introduction and Background

Overview

The State governments formulated their budgets for 2009-10 against the background of the knock-on effect
of the global financial crisis on the Indian economy. Taking cognizance of uncertain growth prospects, many
State governments announced fiscal stimulus packages to sustain the growth momentum. In this context the
fiscal correction and consolidation witnessed in State finances in the recent past provided the fiscal space for
the stimulus. Consequently, the overall Gross Fiscal Deficit (GFD)-GDP ratio is estimated to increase to 3.2
per cent in 2009-10 (Budget Estimates) from 2.6 per cent in 2008-09 (Revised Estimates) and 1.5 per cent in
2007-08 (Accounts). As the recovery process sets in, the States need to return to the path of fiscal
consolidation.

Introduction

The period up to 2007-08 witnessed a considerable improvement in the consolidated fiscal position of State
governments. States were given incentives by the Twelfth Finance Commission (TwFC) to implement their
own Fiscal Responsibility Legislation (FRL) in the form of conditional debt restructuring and interest rate
relief. However, the economic slowdown following the knock-on effect of the global financial crisis and the
accompanying moderation in the pace of revenue growth adversely affected the finances of the States in
2008-09.
Some states in India have been given special status, The special status is in the context of Centre-state
finances. A special category state gets preferential treatment in federal assistance and tax breaks. There were
only three such states in 1969, when the Gadgil formula for sharing central Plan assistance among states was
devised. Now, there are 11-the seven north-eastern states, Sikkim, Uttarakhand , Jammu and Kashmir and
Himachal Pradesh. They are given a higher share of the Union government’s resource allocation because of
harsh terrain, backwardness and other social problems.
States, while presenting their budgets for 2009-10, seem to have taken into account the likely
impact of a slowdown in their tax collections and Central transfers. In order to deal with the
slowdown, a few State governments announced dedicated fiscal stimulus packages in order to boost demand,
while many other States announced sector specific tax reductions. However, the focus of the additional
expenditure in 2009-10 appears to be through revenue expenditure as reflected in higher revenue
expenditure as a ratio to gross state domestic product (GSDP) in many States, rather than capital
expenditure. In fact, a majority of the State governments have budgeted a lower capital outlay as percentage
to GSDP for 2009-10.

Background

The Indian Constitution, in its Seventh Schedule, assigns the powers and functions of the center and the
states. The schedule specifies the exclusive powers of the center (the Union list) and the states (the State
list), and those under joint jurisdiction (the 4 Concurrent list). All residuary powers are assigned to the
center. The nature of the assignment of expenditure functions is fairly typical of federal nations, and broadly
fits with economists’ theoretical rationale.2 The functions of the central government are those required to
maintain macroeconomic stability, international trade and relations, and those having implications for more
than one state. The major subjects assigned to the states comprise public order, public health, agriculture,
irrigation, land rights, fisheries and industries and minor minerals. The states also assume a significant role
for subjects in the Concurrent list, such as education and transportation, social security and social insurance.
The assignment of tax powers in India was based on a principle of separation, with tax categories being
exclusively assigned either to the center or to the states. Most broad-based taxes have been assigned to the
center, including taxes on income and wealth from non-agricultural sources, corporation tax, taxes on
production (excluding those on alcoholic liquors) and customs duty. A long list of taxes is assigned to the
states, but only the tax on the sale of goods has been significant for state revenues. This narrow effective
tax base is largely a result of political economy factors that have eroded or precluded the use of taxes on
agricultural land or incomes by state governments. The center has also been assigned all residual tax powers.
The tax assignment system has some problematic features. The separation of income tax powers between the
center and states based on source (agriculture vs. non-agriculture) has created avenues for evasion.

Special Category States

The special status is in the context of Centre-state finances. A special category state gets preferential
treatment in federal assistance and tax breaks. There were only three such states in 1969, when the Gadgil
formula for sharing central Plan assistance among states was devised. Now, there are 11-the seven north-
eastern states, Sikkim, Uttarakhand, Jammu and Kashmir and Himachal Pradesh. They are given a higher
share of the Union government’s resource allocation because of harsh terrain, backwardness and other social
problems. All of them also happen to be border states.
Objective and Scope

To analyze the current state finances utilizing the various RBI reports as our primary data source.

Methodology

We obtained data from the various sources such as the Reserve bank of India website, the website of the
finance minister of India and the ADBI website etc and conducted a thorough analysis. The graphs and
charts were obtained and we tries to make sense from the charts and tried to find reasons for the trends that
were observed.
Project Findings

Deficit Indicators

We analyse the State-wise movement of key deficit indicators, viz., Revenue Deficit (RD), Gross Fiscal
Deficit (GFD) and Primary Deficit (PD) during the period 2005-08 (Average) to 2008-09 (RE).

Revenue Deficit – “ Revenue Expenditure – Revenue Receipts”. Revenue deficit is the deficit that arises
when the government’s actual net receipts is lower than the projected receipts.

Fiscal Deficit – “ Total Expenditure – Total receipts + Market Borrowings and other Liabilities”.
The difference between total revenue and total expenditure of the government is termed as fiscal deficit. It is
an indication of the total borrowings needed by the government. While calculating the total revenue,
borrowings are not included. Generally fiscal deficit takes place due to either revenue deficit or a major hike
in capital expenditure.

Primary Deficit – “Fiscal deficit + Interest Payment “.

It is the pure deficit which is derived after deducting the interest payments component from the total deficit
of any budget .

The Following table shows the deficit indicators of the state governments of India.

TABLE-1
Deficits as a whole

The impact of the macroeconomic slowdown on State finances appears to be across the states. Out of the 28
States, the number of States which have budgeted revenue deficit in 2009-10 has increased to 14 (4 States in
2008-09) with 10 more States turning from revenue surplus to revenue deficit in 2009-10 (BE). Furthermore,
nine other States have budgeted a lower revenue surplus as compared with 2008-09 (RE). As far as GFD is
concerned, 18 States were able to contain their GFD-GSDP ratio below 3.0 per cent in 2007-08. However,
the number of States with the GFD-GSDP ratio less than 3.0 per cent decreased to 9 in 2008-09 (RE) and 6
in 2009-10 (BE). In short, out of the 28 States, 22 States have budgeted a GFDGSDP ratio above the FRL
target of 3 per cent. The following graph depicts the above findings.

Fig-1

Revenue Deficits Surplus of States

FIG-2

During 2008-09 , four States, viz., West Bengal, Punjab, Kerala and Rajasthan recorded revenue deficit.
Rajasthan was the new entrant in the list of revenue deficit States during 2008-09, while Jharkhand turned
from a revenue deficit to a revenue surplus State. West Bengal, Kerala and Punjab remained revenue deficit
States during the period. However, Kerala and Punjab albeit continued to be in deficit but recorded a decline
in their revenue deficits.
The level of revenue surplus as a ratio to GSDP declined sharply in the case of Chhattisgarh (2.6 per cent),
Orissa (1.7 per cent), Karnataka (1.4 per cent) and Haryana (1.2 per cent) in 2008-09 as compared with
2005-08 (Average). Notwithstanding the slowdown, Jharkhand, followed by Bihar and Uttar Pradesh
witnessed a
noticeable improvement in their RD-GSDP ratio in 2008-09 (RE) over 2005-08 (Average).4.8 During 2008-
09, Bihar registered the highest revenue surplus of 3.0 per cent of GSDP, followed by Madhya Pradesh (2.0
per cent of GSDP), Chhattisgarh (1.3 per cent of GSDP) and Uttar Pradesh (1.1 per cent of GSDP). The
revenue surplus of higher order in these States would help them to finance their investment projects without
accelerating their outstanding liabilities. On the other hand, West Bengal registered the highest revenue
deficit of 3.7 per cent of GSDP, followed by Punjab (2.5 per cent of GSDP) and Kerala (2.0 per cent of
GSDP) in 2008-09 (RE). RD formed a significant portion of GFD in these States, especially in West Bengal
(99.9 per cent), followed by Kerala (59.1 per cent) and Punjab (55.6 per cent). Ideally, the borrowings
should be utilised to generate assets to ensure income for the State governments. However, the perpetual
deficit in the revenue account compelled these State governments to divert the funds from capital account to
finance revenue deficit. However, during
the recent years there have been sincere efforts by States to reduce their revenue deficits. The reduction in
the level of borrowings to meet the revenue deficit has created fiscal space for the State governments to
enhance expenditure on developmental activities. However, the implementation of the Sixth Central/State
Pay Commission during 2008-09 and 2009-10 may put pressure on some State governments as revenue
deficit will pre-empt borrowed funds for revenue expenditure.

Gross Fiscal deficits/surplus of states

Fig-3
The Central Government allowed the Statesto raise additional market borrowings to the extent of 0.5 per
cent of GSDP in 2008-09 for undertaking capital investments thereby permitting the GFDGSDP ratio to the
level of 3.5 per cent. In 2008-09, only seven States viz., Haryana, Orissa, Maharashtra, Tamil Nadu,
Chhattisgarh, Andhra Pradesh and Gujarat could adhere to the TwFC target of reducing the GFD-GSDP
ratio to 3.0 per cent, as compared to ten States in 2005-08 (Average). The GFD-GSDP ratio has increased to
more than 3.0 per cent in case of ten States such as Bihar, Uttar Pradesh, Jharkhand, Goa, Punjab, West
Bengal, Karnataka, Kerala, Madhya Pradesh and Rajasthan in 2008-09 (RE). Barring Jharkhand and West
Bengal, all the non-special category States registered an increase in the GFD-GSDP ratio in 2008-09 (RE) as
compared with 2005-08 (Average). However, the position of Andhra Pradesh remained the same at 2.8 per
cent of GSDP during the period. Among the States which have witnessed an increase in the GFD-GSDP
ratio over the same period, Bihar, Orissa, Chhattisgarh, Haryana and Uttar Pradesh registered the highest
increase. Bihar registered the highest GFD-GSDP ratio of 6.5 per cent of GSDP in 2008-09 (RE), followed
by Uttar Pradesh (5.3 per cent of GSDP) and Jharkhand (4.9 per cent of GSDP).

Expenditure
 Revenue
We would be examining the Tax and Non-Tax revenues of the states of India.

Tax Revenues - Revenue generated by the government in the form of taxes

Non- Tax Revenues- Government revenue not generated from taxes. Examples include
 Aid from another level of government (intra governmental aid)
 Aid from abroad (foreign aid)
 Revenues from sales of state assets etc.

Revenue receipts of the state Governments

Table-2
The total revenue receipts of all the non special category States increased in 2008-09 (RE) over 2005-08
(Average) in terms of GSDP except Karnataka, Haryana, Gujarat and Maharashtra. However, in a majority
of the States the increase is more due to Central transfers and less due to their own efforts. Only West
Bengal is the exception, where the increase is more due to own efforts and less due to Central transfers. In
some States such as Haryana, Karnataka, Maharashtra, Gujarat, Chhattisgarh, Orissa and Rajasthan own
revenue collections (as per cent to GSDP) decreased in 2008-09 (RE) over 2005-08(Average). Jharkhand
recorded the highest improvement in own revenue effort in 2008-09 (RE) over 2005-08 (Average), followed
by West Bengal, Goa, Bihar and Madhya Pradesh Bihar registered the highest revenue receipts(RR)-GSDP
ratio of 31.6 per cent in 2008-09 (RE), mainly backed by the highest current transfers (CT)- GSDP ratio.
Bihar was followed by Madhya Pradesh(22.5 per cent), Orissa (21.9 per cent), Uttar Pradesh(21.9 per cent),
Jharkhand (21.0 per cent) and Chhattisgarh (20.8 per cent). In all these States, Central transfers contributed
significantly to the improvement in revenue receipts.
Own Tax Revenues of states

Fig-4
Karnataka registered the highest own tax revenue (OTR)-GSDP ratio of 10.7 per cent in 2008-09 (RE),
followed by Tamil Nadu (9.9 per cent), Andhra Pradesh (9.6 per cent) and Madhya Pradesh (9.0 per cent). It
may be noted that the OTR-GSDP ratio of West Bengal (4.7 per cent) was one of the lowest in the non-
special category States, followed by Bihar (5.5 per cent), Orissa (6.3 per cent) Jharkhand (6.6 per cent) and
Gujarat (6.7 per cent) in 2008-09 (RE). These five States are still below the TwFC target of the OTR-GSDP
ratio of 6.8 per cent. State governments like Bihar need to improve their OTR-GSDP ratio as their level is
quite low as compared to the TwFC target of 6.8 per cent. Except Jammu and Kashmir and Uttarakhand ,
non of the special category states could meet the TFC target of 6.8% of own tax revenue.

Own Non-Tax Revenues of states

Fig-5

Own non-tax revenue played a significant role in Goa (ONTR-GSDP of 6.4 per cent) and Jharkhand
(ONTR-GSDP of 2.9 per cent) in bringing down the deficit indicators. Some States such as Bihar (ONTR-
GSDP of 0.4 per cent),Karnataka (ONTR-GSDP of 0.7 per cent), Kerala (ONTR-GSDP of 0.7 per cent) and
Gujarat (ONTRGSDP of 1.2 per cent) displayed dismal performances in own non-tax revenue efforts and
these four States are below the TwFC target of the own non-tax revenue (ONTR)-GSDP ratio of 1.4 per
cent. It is important to mention here that the expenditure on economic, social and general services by State
governments is very high but the recovery from these services is insignificant. This is mainly on account of
low cost recovery from publicly provided economic and social services, low profitability of Public Sector
Undertakings (PSUs), low interest recovery from local bodies, cooperatives and others.
The total revenue receipts in terms of GSDP increased in all the special category States, except Uttarakhand,
in 2008-09 (RE) over 2005-08 (Average). The increase in revenue receipts in 2008-09 (RE) in all the special
category States, except Jammu and Kashmir, was mainly on account of current transfers rather than their
own efforts. Sikkim registered the highest increase in CT followed by Arunachal Pradesh, Meghalaya,
Mizoram, Assam and Manipur in 2008-09 (RE) as compared to 2005-08 (Average). During 2008-09 (RE),
only Uttarakhand witnessed a decline in the current transfers (CT)- GSDP ratio over 2005-08 (Average).
This implies that CT played a significant role in the higher revenue surplus recorded by the special category
States in 2008-09 (RE) over 2005-08 (Average). Thus, the fiscal stability of the special category States is
predominantly dependent on Central Transfers.
Recommendations
 References
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