Why managing fiscal is a 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 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.

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).