{"id":366517,"date":"2026-07-01T18:29:06","date_gmt":"2026-07-01T12:59:06","guid":{"rendered":"https:\/\/forumias.com\/blog\/?p=366517"},"modified":"2026-07-01T18:29:06","modified_gmt":"2026-07-01T12:59:06","slug":"the-fiscal-tightrope-for-state-governments","status":"publish","type":"post","link":"https:\/\/forumias.com\/blog\/the-fiscal-tightrope-for-state-governments\/","title":{"rendered":"The Fiscal Tightrope for State Governments"},"content":{"rendered":"

UPSC Syllabus: Gs Paper 2 – <\/strong>Issues and challenges pertaining to the federal structure<\/p>\n

Introduction<\/strong><\/h2>\n

Many Indian States are facing growing fiscal stress despite achieving significant social and economic progress. While taxation powers largely rest with the Union government<\/strong>, States carry a larger share of public expenditure on welfare and development. Kerala and Tamil Nadu show that rising debt is not always a sign of fiscal mismanagement. Instead, it often reflects the gap between expanding development responsibilities and the limited fiscal capacity available to State governments.<\/p>\n

Fiscal Position of State Governments<\/strong><\/h2>\n
    \n
  1. Rising Debt from Persistent Deficits:<\/strong> State debt increases when government expenditure remains higher than tax and other receipts for many years. These deficits are mainly financed through market borrowings, which also increase interest payments.<\/li>\n
  2. Reliance on Limited Revenue Sources:<\/strong> Tamil Nadu depends heavily on liquor sales and property registrations<\/strong> for revenue. Heavy dependence on a few revenue sources can reduce fiscal flexibility and increase financial pressure if these revenues decline.<\/li>\n
  3. States Carry Larger Spending Responsibility:<\/strong> While the Union government<\/strong> holds most taxation powers, State governments undertake a larger share of public expenditure. They spend heavily on health, education, agriculture, and irrigation<\/strong>, which directly affect people’s lives.<\/li>\n
  4. Dependence on Multiple Revenue Sources:<\/strong> States finance expenditure through State Goods and Services Tax (SGST), sales tax, Union tax devolution, grants, loans, and market borrowings<\/strong>. Their financial position depends on both their own revenues and fiscal support from the Union government.<\/li>\n
  5. Kerala’s Revenue Position:<\/strong> Kerala mobilises strong own-tax revenues, with per capita collections about 1.5 times the all-India average<\/strong>. However, it received only 1.92% of Union tax devolution<\/strong>, lower than its 2.6% share of India’s population in 2023-24<\/strong>.<\/li>\n<\/ol>\n

    Why Do States Need Higher Public Expenditure?<\/strong><\/h2>\n
      \n
    1. Investment in Human Development:<\/strong> Higher public spending has supported better social outcomes in Kerala and Tamil Nadu for decades. During 2020-23<\/strong>, their per capita social expenditure remained 30% and 20% higher<\/strong>, respectively, than the all-State average.<\/li>\n
    2. Essential Public Services:<\/strong> A large share of State expenditure goes towards salaries of teachers, doctors, nurses, police personnel and other public employees. These services cannot be maintained without adequate public spending.<\/li>\n
    3. Support for Welfare Commitments:<\/strong> In Kerala, around 20%<\/strong> of total expenditure goes towards salaries, 15.3%<\/strong> towards pensions, and 16.5%<\/strong> towards interest payments.<\/li>\n
    4. Need for Future-Oriented Investment:<\/strong> States require greater investment in infrastructure, higher education, research and public transport to build future productive capacity and support long-term development.<\/li>\n<\/ol>\n

      Structural Causes of Fiscal Stress<\/strong><\/h2>\n
        \n
      1. Limited Fiscal Space for Capital Investment:<\/strong> Kerala could allocate only 10%<\/strong> of its financial resources towards capital expenditure. Most spending was absorbed by day-to-day revenue expenditure, reducing investment in future productive capacity.<\/li>\n
      2. Balancing Welfare and Fiscal Stability:<\/strong> Reducing salaries, pensions or other revenue expenditure may create fiscal space, but it can weaken the social achievements built over several decades.<\/li>\n
      3. Weak Revenue Mobilisation:<\/strong> Fiscal stress is not caused only by rising debt. Tamil Nadu shows that weak growth in State Own Tax Revenue (SOTR)<\/strong>, tax leakages and poor tax collection can also weaken State finances even when the economy grows rapidly.<\/li>\n
      4. High Cost of Borrowing:<\/strong> Indian States borrow through State Development Loans (SDLs)<\/strong> at 6.5-7.5%<\/strong>, which is 0.25-0.75 percentage points<\/strong> higher than Union government borrowing. This raises interest costs and increases fiscal pressure.<\/li>\n<\/ol>\n

        Developmental Consequences of Fiscal Constraints<\/strong><\/h2>\n
          \n
        1. Pressure on Economic Transformation:<\/strong> Kerala requires greater investment to develop knowledge-intensive sectors. Limited public investment reduces its ability to generate quality jobs for educated youth.<\/li>\n
        2. Growing Outmigration:<\/strong> Many educated young people leave Kerala because the State cannot provide sufficient educational and employment opportunities that match their aspirations.<\/li>\n
        3. Private Wealth but Limited Public Investment:<\/strong> Kerala shows visible signs of private prosperity, including expensive houses, cars and gold shops. However, weak public finances limit investment and may increase inequalities.<\/li>\n
        4. Idle Domestic Savings:<\/strong> Kerala’s credit-deposit ratio is only around 66%<\/strong>, compared to the national average of 76%<\/strong>. If even part of these surplus savings had been invested, the State’s capital expenditure between 2016 and 2026<\/strong> could have been at least doubled.<\/li>\n
        5. Pressure on Growth Aspirations:<\/strong> Fiscal stress makes it difficult for States to invest enough to achieve ambitious economic and development goals despite strong economic potential.<\/li>\n<\/ol>\n

          Lessons from China’s Local Government Financing<\/strong><\/h2>\n
            \n
          1. Local Governments Drive Investments:<\/strong> In China, provinces and lower-level governments undertake a major share of public investment. Their borrowing is supported by central planning and large domestic savings.<\/li>\n
          2. Multiple Financing Channels:<\/strong> Chinese local governments raise resources through Local Government Bonds (LGBs), land sales, Local Government Financing Vehicles (LGFVs)<\/strong> and central fiscal transfers.<\/li>\n
          3. Lower Borrowing Costs:<\/strong> Chinese local governments borrow from their banking system at around 2%<\/strong>, much lower than borrowing costs faced by Indian States. Lower interest costs support larger public investment.<\/li>\n
          4. Public Savings Can Support Development:<\/strong> Government securities in India are largely purchased by domestic banks and insurance companies using public savings. Better fiscal structures can help States access these savings more easily and at lower cost for development projects.<\/li>\n<\/ol>\n

            Way Forward<\/strong><\/h2>\n
              \n
            1. Strengthen State Revenue Mobilisation:<\/strong> States should improve tax administration, plug revenue leakages and identify new revenue sources so that State Own Tax Revenue (SOTR) grows in line with economic growth.<\/li>\n
            2. Improve Union\u2013State Fiscal Cooperation:<\/strong> States should work more closely with the Union government to make better use of central schemes and available fiscal support.<\/li>\n
            3. Restructure Public Debt:<\/strong> Existing debt should be restructured to reduce interest costs, as committed expenditure leaves States with limited spending flexibility.<\/li>\n
            4. Reform Loss-making Public Sector Undertakings:<\/strong> Power and transport public sector undertakings should be restructured to reduce the long-term fiscal burden. Public-Private Partnership (PPP) models can also be considered while protecting workers’ welfare.<\/li>\n
            5. Rationalise Welfare Expenditure:<\/strong> Welfare programmes should be reviewed to remove duplication. New cash transfer schemes should not be added without restructuring existing schemes.<\/li>\n
            6. Target Welfare Benefits Better:<\/strong> Welfare schemes should reach the intended beneficiaries so that public spending remains fiscally sustainable over the long term.<\/li>\n
            7. Mobilise Domestic Savings for Development:<\/strong> Fiscal structures should allow States to access domestic savings more easily and at lower borrowing costs to finance carefully planned development projects.<\/li>\n
            8. Strengthen Stable Revenue Sources:<\/strong> States should improve existing revenue sources, such as property registrations and other sustainable tax avenues, to reduce long-term fiscal pressure.<\/li>\n<\/ol>\n

              Conclusion<\/strong><\/p>\n

              State government debt should be viewed in the context of growing development responsibilities and limited fiscal capacity rather than simply as fiscal mismanagement. Stronger revenue mobilisation, efficient expenditure and lower borrowing costs can improve the financial position of States. Fiscal structures should also enable States to access domestic savings more easily to finance long-term development and economic growth<\/p>\n

              Question for practice:<\/strong><\/p>\n

              Examine the major causes of fiscal stress faced by State governments and suggest measures to strengthen their fiscal capacity while sustaining development and welfare expenditure.<\/p>\n

              Source<\/strong>: The Hindu<\/a><\/p>\n","protected":false},"excerpt":{"rendered":"

              UPSC Syllabus: Gs Paper 2 – Issues and challenges pertaining to the federal structure Introduction Many Indian States are facing growing fiscal stress despite achieving significant social and economic progress. While taxation powers largely rest with the Union government, States carry a larger share of public expenditure on welfare and development. Kerala and Tamil Nadu… Continue reading The Fiscal Tightrope for State Governments<\/span><\/a><\/p>\n","protected":false},"author":10320,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"jetpack_post_was_ever_published":false,"footnotes":""},"categories":[1230],"tags":[212,8131,10498],"class_list":["post-366517","post","type-post","status-publish","format-standard","hentry","category-9-pm-daily-articles","tag-gs-paper-2","tag-social-issues","tag-the-hindu","entry"],"jetpack_featured_media_url":"","views":"","jetpack_sharing_enabled":true,"_links":{"self":[{"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/posts\/366517","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/users\/10320"}],"replies":[{"embeddable":true,"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/comments?post=366517"}],"version-history":[{"count":0,"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/posts\/366517\/revisions"}],"wp:attachment":[{"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/media?parent=366517"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/categories?post=366517"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/forumias.com\/blog\/wp-json\/wp\/v2\/tags?post=366517"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}