BS@50: How money has moved between Centre and states in the past 5 decades

Annual government spending has shot up. Fiscal deficit concerns remain. Between the Centre and states, sometimes one has scored over the other. An overview of government finances since 1975

In 1975, the size of India’s annual government spending, incurred by the Centre, 22 states and eight Union Territories, was about Rs 15,690 crore. This was equivalent to about 20 per cent of India’s gross domestic product (GDP) that year. In the last 50 years, by 2023-24, not only has the number of states grown to 28, but the size of their annual spending along with that of the eight Union Territories and the Centre has also shot up to nearly Rs 90 trillion — that is over 30 per cent of India’s GDP.

That India’s government system has seen such a huge rise in its spending over the last half a century is obvious. But how large is this increase? A comparison with the US Federal government provides a clue. The US Federal government’s total outlay in 1975 was about 18 per cent of the country’s GDP. It has gone up in the last 50 years, but not as fast as India’s. In 2024, the US Federal government’s total outlay was estimated at $6.5 trillion, accounting for about 23 per cent of its GDP.

But comparisons tell you only a partial story. Let us dig a little deeper into these numbers for a more comprehensive understanding of the way India’s government finances have fared in the past 50 years.

For almost 40 years after 1975, the combined spending power of the states stayed well below the Centre’s. In 1975, for instance, the states’ outlay as a per cent of GDP was almost half of the Centre’s. But as the number of states rose and their governments grew in strength, their spending increased over the years, and by 2016-17, it exceeded that of the Union government. The share of that spending in GDP kept rising until Covid brought it to a halt.

Indeed, the first year of Covid, 2020-21, saw a trend reversal, with the Centre’s annual expenditure going up to 17 per cent of GDP, while that of states stayed at about 14 per cent. A year earlier, the Centre’s spending was about 13 per cent of GDP, while states accounted for a little more at 13.6 per cent.

Remarkably, in the last three years, the Centre’s expenditure growth has been contained, with its share in GDP estimated at 15 per cent in 2023-24, signifying a sharp drop of about two percentage points since the high of 2020-21. States, in contrast, have shown an increase, from 14 per cent of GDP in 2020-21 to about 16 per cent in 2023-24. While Covid drove both the Centre and states to loosen their purse strings, the post-Covid years saw the Centre displaying greater fiscal discipline by keeping a check on its expenditure. States, meanwhile, have shown no such restraint.

Not surprisingly, the Centre’s fiscal deficit in the post-Covid period has witnessed a sharper decline than that of  states. While the Centre’s fiscal deficit in 2023-24 fell to 5.6 per cent of GDP, compared to 9.17 per cent in 2020-21, states reported their fiscal deficit at 3.2 per cent last year, compared to 4 per cent in 2020-21. The slower reduction in states’ deficit has also meant that the overall deficit of the country’s government system continues to remain high at 8.7 per cent.

High fiscal deficit has been a consistent problem for India over the last 50 years. Indeed, the combined fiscal deficit of the government system was over 10 per cent of GDP in at least 10 years from 1975 to 2024. This includes four consecutive years of the Rajiv Gandhi government from 1984-85 to 1987-88, two years at the height of India’s unprecedented economic crisis in 1989-90 and 1990-91, two years during the tenure of the Atal Bihari Vajpayee government in 1998-99 and 2001-02, and two years during the Covid pandemic.

Interestingly, in nearly all the years when India faced double-digit fiscal deficit, the bigger culprit of fiscal imprudence was the Centre, and not states. Also notable is the fact that the problem of double-digit fiscal deficit did not emerge in the first 10 of these 50 years, although there were clear signs that such a problem was in the making during that period.

On the expenditure side, the pattern seen over the last five decades reflects the shifting emphasis in policymaking in the Union government.

For states, capital expenditure growth has maintained a steady pace. Except for the last five years of the 20th century, states’ capex as a share of GDP has remained above 3 per cent over the last five decades. In as many as 17 of those 50 years, it crossed 4 per cent. Thus, the rise in states’ capex in the post-Covid years is not unusual.

For the Centre, capex declined precipitously from the 1990s, when the economy was in deep trouble, forcing the government to unleash major economic reforms and follow a fiscal consolidation path. Between 1975 and 1990, the Centre’s capital outlay was between 5.4 and 7 per cent of GDP. This was certainly commendable, although a large part of it was funded through borrowing, which led to India’s fiscal crisis in 1990. The share of capex in GDP started falling from the early years of the 1990s, understandably due to the government’s concern for fiscal consolidation.

At the turn of the century, the Centre’s capex was around 2.4 per cent of GDP. Barring the two years of 2003-04 and 2004-05, when capex revived briefly, the Centre’s capital outlay saw anaemic growth, plunging to a low of 1.6 per cent in 2014-15. It was only after Covid that the Centre’s capex began rising rapidly, from 1.67 per cent of GDP in 2019-20 to 3.21 per cent in 2023-24. This was a result of the Modi government’s conscious decision to boost investment and revive growth at a time when the private sector shied away from investing.

On taxation, however, the last half a century has seen a slow rise in the tax-to-GDP ratio. Tax collections by the Centre and states were just about 11.6 per cent of GDP in 1975. By the end of March 2024, that figure stands close to 18 per cent. Rising tax collections have, however, benefitted states more as the devolution formula has become more generous for them over the years. From 1.5 per cent of GDP in 1974-75, the share of states in central taxes has risen to over 3 per cent in 2023-24.

Where states have done better than the Centre is in non-tax revenues — at 4.6 per cent of GDP in 2023-24, compared to 2.9 per cent in 1974-75. The Centre’s performance in non-tax revenues has been poor, with collections last year (1.36 per cent of GDP) lower than what was achieved in 1974-75 (1.69 per cent of GDP).

The broad trends in government finances in the last 50 years, therefore, underline the key challenge that the Centre and states face in the coming years. Their expenditure has grown at a much faster pace than their revenue, which is mainly through tax collections. If governments have to keep spending more on infrastructure, education, healthcare and reskilling of human capital, without compromising on fiscal prudence, then they have to devise ways of improving revenue, particularly tax collections. For the Centre and states, this will be the primary challenge over the next 50 years.