Challenges of sub-national fiscal correction

Source: The post is based on an article “Challenges of sub-national fiscal correction” published in the “The Hindu” on 30^th August 2022.

Syllabus: GS 3 – Budgeting

News: Recently, the RBI released data on the States’ outstanding debt, which has registered an upward movement.

There has been an increase in the Debt-GSDP ratio (gross state domestic product) between 2013 and 2022.

They could be partly due to increased public expenditure due to the implementation of the Ujjwal DISCOM Assurance Yojana (UDAY), farm loan waivers, other freebies, etc. Further, the revenue mobilization efforts have failed.

What are the arguments for the grant of the freebies?

States push back on this issue on the grounds of welfare provisioning and protection of the vulnerable sections of the population.

What are the different federal issues between the state and central governments?

(1) First, There have been a set of issues related to Goods and Services Tax (GST) such as the rate structure, inclusion and exclusion of commodities, revenue sharing from GST, and associated compensation.

(2) Second, State-level expenditure patterns, especially related to the welfare schemes of States. This is a key issue related to the quantity and quality of public expenditure by the State governments.

(3) Third, the conception and the implementation of central schemes.

However, the most pressing issue at hand is the State-level expenditure patterns. There are two kinds of public expenditures: 1) Mandatory spending: governed by formulas or criteria set forth, and 2) Discretionary spending: governed by annual or other periodic appropriations.

Center is pushing for more fiscal discipline by reducing the scope for discretionary spending and limiting States to focus on mandatory expenditures. Whereas, states are looking for more fiscal space for increasing discretionary spending.

What are the issues associated with discretionary spending?

(1) Once started, some of the discretionary expenditure, used to increase demand in the economy, continues for longer periods leading to fiscal stress. This is because it is hard to decrease government spending, especially due to the resistance from the public.

(2) In a federal system, States’ fiscal stress gets spilled over to the Centre, leading to a situation of overall magnified fiscal slippages.

(3) As the economy is recovering from the crisis, there exists a need to adhere to the path of fiscal correction both by the Centre and by the States.

(4) Many States indulge in higher levels of expenditures towards maintaining what they call their ‘models of welfare provisioning’.

(6) Sustained increase in welfare expenditure by the States leads to fiscal expansion, which necessitates additional resource mobilization. However, limited success in additional resource mobilization forced the state governments to resort to borrowing. Fiscal expansion financed through debt and the resultant debt accumulation have important impacts on the economy.

What should be the course of action?

The funds raised through borrowings must be used for capital formation. This would contribute to the real income of future generations and add to the repayment capacity of the government as well.

There is a need for fiscal correction or fiscal consolidation at the State level. This can be done by raising additional resources at the sub-national levels, and simultaneously, ensuring expenditure prioritization.

The Central government must demonstrate its commitment to fiscal discipline in order to ensure a cooperative federal structure.