BS Number Wise: Indian states are living dangerously on subsidies

Their tax revenues can't keep up with their largesse: it's a policy that risks putting them in economic peril

Subsidies were ample in the mercantilist period before the industrial revolution. The British paid bounties to increase corn exports in the late 17th century. During the First World War, the US government subsidised oil producers to drum up production, and in the late 1920s, it subsidised farmers to keep demand and supply in check.

In India, subsidies protect industry and help the poor. While subsidies are a tool of emancipation for economists, politicians use them to win support.

Pakistan and Sri Lanka are in crisis partly because of the burden of subsidies. Two weeks ago, Indian civil servants advised the prime minister that the politics of subsidies would lead the country down the same path.

An analysis of subsidies across different levels of Indian governance is unavailable, as even local governments provide some. One source for such information is the Reserve Bank of India’s study of state finances between 2018-19 and 2020-21.

A Business Standard analysis found that between 2018-19 and 2020-21, the compounded annual growth rate of subsidies was greater than that of states’ own revenues. The combined subsidy bill of Indian states increased 12.7 per cent from Rs 1.87 trillion in 2018-19 to Rs 2.38 trillion in 2020-21. In the same period, states own tax revenues jumped 1.1 per cent from Rs 12.14 trillion to Rs 12.41 trillion. As a result, subsidies as a proportion of states’ own tax revenue increased from 15.4 per cent to 19.2 per cent. The ratio is expected to decline to 15.6 per cent in 2021-22 (as per budget estimates), assuming that tax collections increase by 28.5 per cent.

Of the 30 states and UTs for which data is available, only 10 had a subsidy-to-own tax revenue ratio of less than 10 per cent in 2020-21. Eleven states had a ratio between 10 per cent and 20 per cent, and nine had a ratio of more than 20 per cent. In contrast, in 2018-19, 14 states had a ratio of less than 10 per cent. The budget estimates for 2021-22 show a slight improvement from the 2020-21 revised estimates.

Some states are in dangerous territory. According to RBI data, Chhattisgarh’s subsidies accounted for 115.9 per cent of its own tax revenues in 2020-21. The state expected a slight improvement to 99.3 per cent in 2021-22, but subsidies will still absorb the entirety of its tax revenues.
 

Punjab’s subsidy bill in 2020-21 was 36 per cent, and it is expected to improve to 34.2 per cent in 2021-22. Bihar had a subsidy burden of 27.2 per cent in 2020-21, Karnataka was 26.5 per cent, and Madhya Pradesh was 25.3 per cent.

With their debts rising, states are spending more on interest payments, administration expenditures, and pensions. Nearly a third of the central government’s tax revenues also went into subsidies in 2021-22, and the ratio was much higher in 2020-21.

Subsidies are important, but politicians running governments need to realise the capacity to pay the bill.