Since July 17, Prime Minister Narendra Modi’s criticism of “revdi culture” – the distribution of sweets – has sparked a heated debate about the merits of good welfare measures and the drag to the economy caused by bad “freebies”.

The discussion has become even more intense with the Supreme Court hearing a public interest litigation against political parties promising social welfare benefits during election campaigns.

Opposition leaders and some economists have pushed back against the notion that welfare schemes are “freebies”. Many welfare schemes, they maintain, are essential for the public good despite the contention that such measures are fiscally irresponsible.

Some states, heavily burdened with high fiscal deficit and debt levels, have actually performed better on developmental outcomes and in ensuring better access equality to essential services for their populations.

States like Kerala, West Bengal have ensured efficient welfare-enhancing schemes that compliment centrally-sponsored schemes. This has helped their populations also do well and ensured high productivity for the nation as well.

Article 293 (3) (4) of the Constitution allows state governments to manage their debt and fiscal policies the way they want while being consistent with the recommendations of the Finance Commission. Despite this, a battle is brewing between the Centre and many states centered on the fiscal autonomy allowed to state governments under the Constitution.

Here is how this is playing out.

States’ fiscal performance

The past two years of the Covid-19 pandemic have wreaked havoc on the fiscal position of states, exacerbating the public debt levels of both the states and the Centre. Yet, the Centre has offered little direct fiscal support for most state governments.

Since health is listed as a state matter in the Indian Constitution, states are expected to incur a higher proportion of healthcare costs. Through the pandemic, most state budgets have been stretched thin. While the Centre did provide support for the direct procurement of vaccines, a lot of that help was too little too late.

During lockdown, when migrant workers and other vulnerable sections were grappling with a loss of income, states were offered liquidity support with the opportunity to borrow through the Reserve Bank of India or the Central government.

States such as Kerala, Tamil Nadu, West Bengal, Telangana – mainly those not ruled by the Bharatiya Janata Party – have been sceptical of the Centre’s actions and have tried to avoid borrowing excessively to meet their increased expenses. (Read more on this from the recent exchange of letters between Kerala state finance minister and Union finance minister.)

Credit: Author calculations from the Handbook of Statistics on Indian Economy by the Reserve Bank of India and Union Budget Documents from 2012-'23.

The issue of state-accrued public debt needs to be seen in the context of each state’s fiscal situation and spending needs.

Limited revenue sources

In the chart below, the 10 selected states account for around half of the total revenue collected by all states and Union territories. For Haryana, Kerala and Andhra Pradesh, tax revenues constitute about half of their total revenue collections. The major source of revenue for other states is Central transfers.

Within their own tax revenue, major sources are the state goods and services tax, state excise duties and sales tax. It also shows how most states are dependent on the Central government for funds.

Credit: Reserve Bank of India bulletin.

According to the Reserve Bank of India, the own tax revenue of some of these 10 states – Madhya Pradesh, Punjab, and Kerala – has been declining over time, making them fiscally more vulnerable to debt exposure and risk.

For most of these states, non-tax revenue from sources such as returns on assets such as profits and rents, fees and fines has remained volatile, dropping significantly in recent years, as seen in the two charts below.

Declining own tax revenue and non-tax revenue hurts the states’ expenditure planning and increases their dependence on market borrowing.

States' own tax revenue and own non-tax revenue. Credit: State Budget Documents & Reserve Bank of India Bulletin.

Some states such as Rajasthan, West Bengal, Punjab, and Kerala spend around 90% of the revenue they collect. The Reserve Bank of India emphasises the need for these states to enhance capital spending or investment expenditure on areas such as infrastructure and power where the return on investment may allow states to accrue more revenues, while complementing this with other welfare-enhancing spending allocations.

But welfare-enhancing fiscal measures on areas such as the Mahatma Gandhi National Rural Employment Guarantee and human capital development spending on education and healthcare have their own multiplier effect in improving developmental outcomes.

For instance, improved healthcare – reducing maternal mortality, infant mortality or improving child nutritional performance – directly influence labour productivity in a state. Such enhancement in labour productivity help further the state’s Gross State Domestic Product Growth.

It also goes without saying that states do need to control their fiscal autonomy – as safeguarded by the Constitution – and spend money as they deem fit while being aware of their macroeconomic debt position, risk exposure, and other socio-economic realities.

How has this played out under the assertive Bharatiya Janata Party-ruled Central government?

Post-Covid situation

Pinaki Chakraborty of the National Institute of Public Finance and Policy, wrote in the Economic and Political Weekly in March that the fiscal challenges for the Union-states have eased but have not disappeared. There are many reasons for this.

The impact of the Ukraine conflict has been significant, as oil prices have shot up around the world.

But mainly, he notes, resources flow to the states in the form of Centrally sponsored schemes such as the rural employment guarantee scheme – under the Mahatma Gandhi National Rural Employment Guarantee Act – the National Social Assistance Programme, Umbrella Programmes on the Development of Scheduled Castes, Scheduled Tribes and Minorities are still substantial.

The aggregate allocation under Centrally sponsored and Central sector schemes as per the 2022-’23 budget allocation is Rs 3.83 lakh crore. This is contributing to the Union government’s high revenue deficit. Since it binds states to make matching contributions, it also increases state-level deficits.

States' Gross Fiscal Deficit in 2020-'21 and 2022-'23. Credit: Reserve Bank of India documents.

Welfare performance of states

The Access (In)Equality Index by the OP Jindal Global University’s Centre for New Economics Studies, with which I work, observed in 2021 how states like Delhi, despite its unique multi-party governance architecture, West Bengal, Kerala and even Goa and Sikkim, perform better than states such as Uttar Pradesh, Bihar and Madhya Pradesh in providing access to basic social and economic services.

Every state has different fiscal capabilities to meet the social and economic needs of its population. But the overall development priorities set by any state government – BJP or non-BJP-ruled – must be closely linked to welfare enhancing measures.

Based on the range of 0.67-0.23, states are grouped into three categories – Aspirants (below 0.33), Achievers (0.42-0.33) and Front Runners (above 0.42). Bihar, Uttar Pradesh, Jharkhand, Assam, Odisha and Madhya Pradesh fall under aspirants, requiring sustained efforts to improve access to basic socio-economic opportunities across all identified pillars.

Maharashtra, Arunachal Pradesh, Gujarat, Uttarakhand, Chhattisgarh, Rajasthan, Tripura, West Bengal, Manipur and Meghalaya are categorised as Achievers. These states must sustain their efforts to advance to the next category.

Lastly, states such as Goa, Sikkim, Tamil Nadu, Kerala, Himachal Pradesh, Telangana, Punjab,Mizoram and Karnataka are listed as Front Runners.

It is worth reiterating the link between state-debt levels and their Access InEquality Index performance for welfare-based comparison.

States like Kerala, Punjab and Telangana, despite their high public debt, have ensured better access to basic social and economic services and have done well consistently across most of the categories that were measured.

At the same time, states like Bihar, Uttar Pradesh, Madhya Pradesh, Assam, and Jharkhand – four of the five are BJP-ruled states – perform the lowest across most of the index pillars and are ranked the lowest in most access-measuring indicators.

Contentious relationship

The recent instances of exchanges and points of contention between state finance ministers and the Ministry of Finance indicate how the Centre is arbitrarily trying to obstruct non-BJP states from exercising their fiscal autonomy.

In managing the swelling fiscal deficit and public debt levels, including of fiscally weak states, fiscal priorities and the composition of public expenditure must be more clearly understood. This is especially so due to the different constitutional assignment of functions for the Union and state governments. Most redistributive expenditures – critical for welfare outcomes – are in the domain of states.

Any contraction of such expenditure at the state level, due to the coercive actions of the Union government or due to high state-accrued public debt, can have adverse consequences, with a regression that can already be observed in state-level performance on access to basic services.

Welfare-driven expenditure needs are not part of “revdi politics” but about securing a government’s basic responsibility to its people and the larger citizenry.

State governments, irrespective of their party affiliation, need all the support they can get at this point to either borrow more freely under a mutually agreed fiscal roadmap for their development needs or be supported to manage their finances on their own, or borrow financed support offered by the Centre.

Fiscal cooperation and transparent functioning are vital for protecting a state’s fiscal space and enhancing macroeconomic stability. There is no room for arbitrary decision-making mechanisms nor partisan constitutional interpretations, which might trigger more direct confrontations between state governments and the Union Ministry of Finance.

Deepanshu Mohan is an Associate Professor of Economics and Director at the Centre for New Economics Studies, Jindal School of Liberal Arts and Humanities, OP Jindal Global University.