T.N. can lead in expenditure reform

Why in news?

Tamil Nadu’s June 2026 White Paper shows a rigid budget – a large share goes to salaries, pensions and interest, and little is left for investment. Tamil Nadu’s new committee on welfare and public spending is to measure spending properly, find out what each rupee achieves and cut leakage, duplication and low-value spending.

The issue is not only about one State. Most States face a mix of limited tax powers, rising committed spending and poor-quality data on what they actually spend.

UPSC Relevance

Prelims – Articles 202, 246A, 270, 275, 276, 280, 282, 293; Finance Commission; FRBM limits; committed expenditure; NITI Aayog Fiscal Health Index.

Mains 

GS2: Issues and challenges pertaining to the federal structure, devolution of powers and finances

GS3: Government budgeting, mobilisation of resources, fiscal policy.

Fiscal powers of States under the Constitution

• Basis – Part XII (Articles 264-293) and the Seventh Schedule divide taxing powers between the Union and the States.
• Own taxes (State List) – Land revenue, agricultural income tax, taxes on land and buildings, stamp duty (rates), excise on alcohol for human consumption, tax on consumption and sale of electricity, motor vehicle tax and tolls.
• Professions tax – Article 276 allows States to levy it, subject to a cap of ₹2,500 per person per year.
• After GST (101st Amendment, 2016) – Article 246A gave both Parliament and States power to levy GST. Most State taxes on goods and services were merged into GST. Sales tax is now limited to petroleum crude, petrol, diesel, natural gas, ATF and alcohol for human consumption.
• Budget – Article 202 requires each State to present an Annual Financial Statement. No tax can be levied or spent without the authority of law and the legislature.
• Borrowing – Article 293 lets States borrow only within India. If a State owes money to the Centre, it needs the Centre’s consent for fresh borrowing – which gives the Centre a strong lever.

How States receive money from the Centre

• Finance Commission (Article 280) – Set up every five years to recommend how central taxes are shared. The 16th FC, chaired by Arvind Panagariya, covers the period 2026-31.
• State Finance Commissions (Articles 243-I and 243Y) – Recommend sharing of State revenue with panchayats and municipalities.

Measuring fiscal health of States

• Fiscal deficit – Total borrowing need of a State. FRBM Acts of States generally cap it at 3% of GSDP. The 15th FC allowed an extra 0.5% for States carrying out power sector reforms.
• Revenue deficit – Revenue spending more than revenue receipts. It means borrowing to pay for day-to-day spending rather than for assets.
• Debt-GSDP ratio – The FRBM Review Committee (N.K. Singh, 2017) suggested a combined general government debt of 60% of GDP – 40% for the Centre and 20% for States. Most States are well above 20%.
• Committed expenditure – Salaries, pensions and interest payments. These cannot be cut easily, so a high share leaves little room for new spending.
• Quality of spending – Measured by the share of capital expenditure and spending on health and education.
• NITI Aayog Fiscal Health Index (2025) – Ranked 18 major States on quality of expenditure, revenue mobilisation, fiscal prudence, debt index and debt sustainability. Odisha topped the list, while Punjab, Andhra Pradesh, West Bengal, Kerala and Haryana were at the bottom.

Challenges to fiscal health of States

• Vertical fiscal imbalance – States carry about 60% of general government spending but raise a much smaller share of revenue, so they depend on the Centre.
• Shrinking tax autonomy after GST – States gave up most indirect taxes. GST compensation ended in June 2022, and GST rate decisions need consensus in the GST Council.
• Cesses and surcharges – Their share in the Centre’s gross tax revenue has risen, and they are not shared with States, so the actual share of States is lower than the 41% on paper.
• Borrowing controls – Since 2022-23, the Centre counts off-budget borrowing by State PSUs within States’ borrowing limits. States like Kerala have challenged this in the Supreme Court.
• Rising committed spending – Pay commission revisions, pensions and interest eat up revenue. Some States have returned to the Old Pension Scheme, which adds long-term burden.
• Populist schemes – Free power, cash transfers and loan waivers without clear funding. The RBI has repeatedly warned about such spending.
• Power discoms – Losses and unpaid subsidies keep coming back to State budgets despite schemes like UDAY (2015) and RDSS (2021).
• Low capital spending – Capex is usually the first to be cut when money is short, which hurts long-term growth.
• Data and transparency gaps – Off-budget borrowings, guarantees and hidden subsidies are not fully reported.

Committee recommendations

Way forward

• Common accounting standards – Reconcile State accounts with GFSM 2014 and move towards accrual accounting, as suggested by the CAG’s Government Accounting Standards Advisory Board.
• Full fiscal picture – Publish all subsidies, guarantees, off-budget borrowings and the full public salary bill in one statement.
• Outcome-based spending – Assess each major scheme for beneficiaries, unit cost, leakage, duplication and outcomes. Expand what works and redesign or close what does not.
• Protect capital spending – Fix a minimum share of budget for capital spending on roads, water, schools and hospitals.
• Own revenue – Improve property tax, stamp duty, mining and excise collection, and use technology to cut evasion.
• Fair federal transfers – Bring cesses and surcharges within limits or into the divisible pool, and give States a stronger voice in GST decisions.
• Independent fiscal councils – State-level bodies to check budget numbers and report publicly.
• Power sector discipline – Make power subsidies explicit and pay them on time to discoms.

States deliver most public services that people use every day – schools, hospitals, police and roads. Their fiscal health is therefore the health of Indian federalism itself. If Tamil Nadu succeeds in measuring spending honestly and linking it to outcomes, it can offer a model that other States can follow.

Practice MCQ

Q1. With reference to the fiscal powers of States in India, consider the following statements:

1. A State can borrow from outside India with the approval of the Reserve Bank of India.

2. A State that owes money to the Union Government needs the Union’s consent to raise a fresh loan.

3. Cesses and surcharges levied by the Union are not part of the divisible pool of taxes.

4. The Constitution caps the professions tax that a State can levy on a person in a year.

How many of the above statements are correct?

(a) Only one

(b) Only two

(c) Only three

(d) All four

Answer: (c)

Explanation: Statement 1 is incorrect. Under Article 293, States can borrow only within the territory of India. The cap on professions tax is ₹2,500 under Article 276.

Q2. Consider the following statements:

Statement-I: The capital expenditure shown in a State’s budget may overstate the actual creation of physical assets.

Statement-II: Capital expenditure in budgets includes loans, equity infusions and repayment of debt, which do not create non-financial assets.

Which one of the following is correct in respect of the above statements?

(a) Both Statement-I and Statement-II are correct and Statement-II explains Statement-I

(b) Both Statement-I and Statement-II are correct but Statement-II does not explain Statement-I

(c) Statement-I is correct but Statement-II is incorrect

(d) Statement-I is incorrect but Statement-II is correct

Answer: (a)

Explanation: Because budget capex includes financial transactions like loans and debt repayment, it can look larger than the actual investment in roads, schools or hospitals. This is why standards like the IMF’s GFSM 2014 separate the two.

Mains Practice Question

“Indian States face a paradox of rising responsibilities and shrinking fiscal autonomy.” Examine the factors affecting the fiscal health of States and suggest measures to improve the quality and transparency of their public expenditure. (15 marks, 250 words)

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