Changing fiscal architecture at state level

Increase in untied funds creates space for adjusting expenditure allocations

A preliminary reading of four of the state Budgets for 2016-17, presented to their respective Assemblies in the past couple of weeks, shows that contrary to fears expressed earlier, states have been able to take advantage of an increase in the financial flexibility given to them by the rise in the quantum of untied central transfer of funds to them. As a consequence, this has allowed the states to adjust their expenditure allocations in accordance with their priority.

This might only be a preliminary analysis, and the national picture will emerge once all states come out with their 2016-17 Budgets. But, the early trends are significant as the Union government is set to present its own Budget for 2016-17 on Monday.

This analysis covers the states of West Bengal, Bihar, Madhya Pradesh and Gujarat, which have already presented their 2016-17 Budgets. Two of them are ruled by the Bharatiya Janata Party and one each by Trinamool Congress and an alliance led by Janata Dal (U).

There are four broad trends that emerge from the analysis.

First, most states did not budget for the increase in their share of central taxes in 2015-16 in the aftermath of the Centre accepting the recommendations of the Fourteenth Finance Commission.

Second, as states had made unrealistic assumptions regarding growth in their own tax revenues, this unaccounted increase in untied transfers in 2015-16 helped offset the shortfall in their own tax collections. Third, contrary to concerns, states have taken advantage of the new found flexibility by adjusting their expenditure allocations according to their changing priorities. While some have increased expenditure on social services, others have chosen to retire their debt.

Fourth, some states have budgeted for a sharp increase in grants in aid from the central government in 2016-17 to boost their revenue receipts.

In February last year, the Centre had accepted the recommendations of the Fourteenth Finance Commission which had recommended that states' share in the divisible pool of taxes be raised from 32 per cent to 42 per cent. Compared to the budgeted share of Rs 5.24 lakh crore in 2015-16, the Centre has so far transferred Rs 4.12 lakh crore to states by way of tax devolution, with the remaining expected to be disbursed by the end of March.

But, as most states had presented their Budgets before the recommendations were accepted, they didn't account for the increase in their share of central taxes. This is borne from the fact that, with the exception of Bihar, states had budgeted for a lower amount in their share of central taxes in 2015-16 compared to the advance estimates (AE). This suggests that transfers from the Centre significantly increased during the year.

This sharp rise in untied funds has given states the flexibility to alter their expenditure allocation according to their changing priorities. Of particular interest is the changing allocation in states during election years.

Take the case of West Bengal and Bihar. West Bengal, which is expected to go to polls this year, had seen a sharp increase in expenditure on economic services in both 2014-15 and 2015-16. But, ahead of the elections this year, the Budget has veered sharply towards greater social sector spending with spending on social sector as a percentage of total spending increasing by roughly four percentage points in 2016-17. The decline has come largely at the cost of lower allocations in percentage terms for economic services.

But, the West Bengal Budget numbers simply don't add up. While the states' own tax revenue grew a mere 8.9 per cent in 2015-16, it is now projected to grow by a whopping 17 per cent in 2016-17. This has been projected despite the state has announced no new taxes. It's possible the state government hopes to improve tax collection efficiency substantially.

In the case of Bihar, where elections were held last year, Budget documents show that expenditure rose by a whopping 40.2 per cent in 2015-16, as opposed to a budgeted 27.4 per cent, with sharp increases in both Plan and non-Plan expenditure. It is likely that spending was ramped up in the months leading up to the state elections. As a result, the state's fiscal deficit doubled from a budgeted estimate of Rs 13,584 crore to Rs 28,505 crore (AE) in 2015-16. The state now expects it to bring it down to Rs 16,014 crore in 2016-17. It has budgeted its total expenditure to grow at a mere 8.9 per cent in 2016-17.

But, this is not going to be an easy task. Bihar is expected to lose around Rs 4,000 crore in excise duty from the proposed ban on liquor. And, while the government has recently increased value-added tax (VAT) on 20 items, it has not introduced any new tax.

The state has budgeted for a 15.8 per cent increase in its own taxes in 2016-17. While this might well be a conservative estimate, its own tax revenue grew at 23.6 per cent in 2015-16; it might not be enough to bring down the fiscal deficit. To bridge the gap, the state is relying on greater financial assistance needed from the Centre. The state has budgeted for a massive 56 per cent increase in grants in aid from the central government in 2016-17, which is the highest among the four states analysed.

Madhya Pradesh, too, has budgeted for a 17.4 per cent increase in grants in aid from the Centre in 2016-17. To fund its expenditure, which is projected to grow at 20.9 per cent in 2016-17, the state has proposed an entry tax of six per cent on goods purchased online in view of revenue 'loss' due to the e-commerce trade to shore up its revenues. It also proposes to impose a VAT of five per cent on bicycles costing above 10,000 and has also proposed to raise VAT on other items.

But, it is difficult to estimate the gain from these measures as the increase could be offset to some degree by the proposed reduction in VAT on canteen store department, cars of the army, soya milk, and dialysis machines. The state has also used the increase in untied funds to rework its expenditure allocations. Spending on capital expenditure as a percentage of total spending is now expected to rise in 2016-17 after falling the past two years. As a consequence, revenue expenditure as a percentage of total expenditure is projected to fall in the coming financial year.

On the other hand, Gujarat has used the new-found flexibility to repay its debt. It proposes to pay back Rs 8,621 crore of debt in 2016-17, up from Rs 5,927 crore in 2015-16. As a consequence, expenditure on social and economic services as a percentage of total expenditure has gone down in its current Budget.