Where Has the Money Gone?

HAVING MANAGED TO EXTRACT from the Union government a sweet deal of guaranteed revenue growth of 14 per cent per annum in the form of a Goods and Services compensation scheme, it is curious as to why many states have ‘empty coffers’ and are run­ning ‘dry treasuries’.

With the monthly Goods and Services Tax (GST) collections touching new highs every passing month— ₹1,65,000 crore last month—on the back of an annual growth in collections of almost 30 per cent in 2021-22 and a healthy growth of 23 per cent in 2022- 23, states should be anything but short of revenue.

In the earlier era, when the share of states in the Union rev­enues was around 15 per cent in 1952-53 which doubled to 30 per cent in 1995-96, the ‘empty exchequer’ was common and understandable. With the share now being 42 per cent and that too of a much larger tax base and far more buoyant sources, there is hardly a revenue imbalance case that can be the reason for an unhealthy fiscal balance in a state.

In fact, from the tax-sharing perspective, the growth in CGST (Central), of which states get a share of 42 per cent, was a whop­ping 40 per cent in 2021-22 and 20 per cent in 2022-23. The SGST (state) collection also kept pace with a growth rate of 34 per cent and 20 per cent. So, too, the growth in IGST (integrated). The rate of growth of devolution has been in excess of 25 per cent in the last two years.

The rate of growth aside, in the GST regime, the tax base that the Union government shares with states is much wider than it has ever been before. It is the tax base associated with Union Excise Duty, Service Tax and parts of Customs Duty, which have been subsumed under IGST. And, of course, the Union govern­ment’s tax base extends to Sales Tax/ VAT, Central Sales Tax, Entry Tax, Luxury Tax, Entertainment Tax, Taxes on Lottery, Betting and Gambling, and Purchase Tax.

It is not surprising then to see that post-GST, the vertical fiscal imbalance ratio has increased to nearly 0.60. This indicates that only 40 per cent of the state’s own expenditure is financed by its own revenue. While there is a need to redefine the concept of “states’ own revenues”, considering the pooling of indirect tax sovereignty, the increase in the vertical imbalance points to a relative faster growth in devolution to states compared to SGST.

A possible reason for the liquidity stress could be emanating from the pattern of IGST sharing. IGST amounting to ₹8,96,994 crore in 2022-23—unlike CGST and collections on account of Customs Duty, Union Excise Duty, Service Tax, and CGST—does not constitute a divisible pool of taxes. Only a part of IGST collec­tion, which is not the credit-in-transition, is part of the divisible pool of taxes.

IGST collected from business-to-consumer transactions or any other transaction where ITC (Input Tax Credit) against IGST can­not be availed are tax proceeds and hence to be shared with states. Therefore, the entire IGST collection is not available for disposal to the Union government as tax proceeds. For this segment there have been delays in sharing it with states, causing what is essen­tially a cash flow problem. So, too, with the release of the GST com­pensation cess that has seen inordinate and inexplicable delays.

States seem to have become adventurous in managing public expenditure. Electoral compulsions have meant the increase is more in transfer payments rather than capital expenditure. Apart from the adverse macroeconomic implication of this strategy, it adds to the stickiness of the expenditure budget

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While there is no doubt that the liquidity issues faced by states is an overhang of the pandemic as well as the release of their share in IGST shares and the GST compensation, the roots of their incip­ient fiscal crisis lie in the inability to reorient their expenditures in the new fiscal system. State budgets, historically by the very nature of their designated responsibilities, are sticky; they have what in corporate terms is an “illiquid balance sheet”.

Before the current liquidity crisis in many states becomes a fiscal crisis, state governments will have to take a hard-nosed look at their public expenditure policy which is anyway largely driven by primary expenditures which are of committed expenditures.

The expenditure budget of a state is largely predetermined. The bulk of it comprises committed expenditure which includes salaries, pensions, and interest payments. These account for more than 60 per cent of the state budget. With the abolition of the plan and non-plan system, and its replacement by the capital and rev­enue expenditure classification, a lot of the committed liability of the plan, the erstwhile plan revenue expenditure, has come on to the revenue expenditure side, making it even more sticky.

Interestingly, with the use of GST com­pensation being earmarked to defray the debt servicing of the special loans contract­ed by states during the pandemic, some re­sources have been freed from the primary expenditure, making these available for the grant of freebies.

Both these factors have effectively meant a ‘soft budget’ constraint for state govern­ments. They seem to have been emboldened to get adventurous in the management of public expenditure. Electoral compulsions have meant that the increase is more in the nature of transfer payments rather than capi­tal expenditure. Quite apart from the adverse macroeconomic implication of this strategy on growth and stability, it adds to the sticki­ness of the expenditure budget. As it is, most of the expenditures, given the nature of their responsibility, are committed expenditures, such as salaries, pensions and interest pay­ments which cannot be rolled back or even re­duced in the short and medium terms. Unlike capital expenditures, revenue expenditures are especially of the transfer payments variety.

If this wasn’t enough, with the shift from plan and non-plan to capex and revenue cat­egories of budget, a whole range of commit­ted liabilities of the previous plans has had to be accounted for on the revenue expenditure side. This inability to rationalise and restruc­ture, let alone reduce, the revenue expendi­ture lies at the heart of the crisis faced by state governments. It is to do with both the level and the composition of expenditure. This double whammy can fast become a binding structural constraint resulting in a fiscal crisis amidst a buoyant revenue situation.

About The Author

Haseeb Drabu

Haseeb Drabu is an economist and the former finance minister of Jammu and Kashmir

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