Under strain, state finances in Kerala and TN need a new fiscal compact

The recent Assembly elections have resulted in a change in political dispensation in three states — Kerala, Tamil Nadu and West Bengal. The new governments in two of these states have tabled white papers on “State Finances” to place on record the challenges they face. Identifying the challenges, one presumes, is the first step towards taking measures to mitigate them. 

Apart from concerns of rising debt levels, both these documents (of the two states) throw light on a few similar concerns on receipts and expenditures. On the expenditure side, they flag the high share of committed liabilities in revenue expenditure and the limited space left for capital expenditure, which constitutes the base for long-term growth in the economy. Kerala reports committed expenditure, including wages and salaries, pensions, and interest payments, at 77 per cent of revenue receipts while Tamil Nadu reports a figure of 64 per cent of revenue receipts. In contrast, capex is limited to 1.3 per cent for Kerala and 1.44 per cent for Tamil Nadu. Both states flag two other concerns on the expenditure side — liabilities on account of public-sector enterprises and challenges in covering the existing liabilities of the state in the form of outstanding dues. 

On the receipts side, the white papers highlight slowdown in the growth of the own tax revenues of these states. The Kerala white paper reflects on the decline in the performance of own tax revenues both in comparison to its own past as well as in comparison to other similar states. The ratio of own tax revenues to gross state domestic product (GSDP) has declined from 6.94 per cent in 2015-16 to 6.41 per cent in recent years, indicating a low buoyancy, largely attributed to SGST (state goods and services tax) performance. The Tamil Nadu white paper too flags a decline in the ratio from a historical high of 8.94 per cent in 2006-07 to a low of 5.45 per cent in 2025-26. 

A few questions arise from a perusal of the white papers. First, are the identified fiscal challenges specific to these two states, or is this a more widespread phenomenon? Second, are there any concrete options available for addressing these challenges?

To understand the fiscal space available to states in the form of growth in revenue receipts, we look at the audited figures for years up to 2024-25 and the cumulatively monthly accounts for March 2026 (of 2025-26). The pre-Covid period witnessed an average annual growth rate in revenue receipts of over 10 per cent — all states taken together. During 2019-21, it dropped close to zero per cent. In the next two years, there is a sharp increase in the rate of growth — 25 per cent in 2021-22 and 13 per cent in 2022-23. Thereafter, there is a clear slowdown — the growth rate for 2023-24 is 8 per cent while that for 2024-25 is 6.8 per cent. Taking the monthly accounts figures, there appears to be a modest improvement to 7.3 per cent. Even for major states taken together, a similar trend is visible. 

Turning to states’ own tax revenues, once again, a similar trend is visible for major states — a growth rate over 10 per cent in the pre-Covid period, compression during the Covid period, followed by a surge in growth for two years before it settles into a more modest growth phase — 13 per cent in 2023-24, 4 per cent in 2024-25 and 5 per cent in 2025-26. Taken together, with a nominal growth rate in gross domestic product (GDP) of 9 per cent in the last two years, it is clear that the ratio of own tax revenues to GDP for states would register a decline, as would revenue receipts. 

On the utilisation of available resources, stress in state finances can be reflected in the extent to which states are utilising their fiscal deficit to finance the revenue deficit. Here too, the scenario shows clear improvement after the pandemic, with the number of major states reporting a revenue surplus increasing to nine in 2022-23. But subsequently the scenario changes. Fewer states report a revenue surplus — eight in 2023-24, six in 2024-25 and five in 2025-26. On the other hand, the number of major states using more than 50 per cent of the fiscal deficit to finance the revenue deficit has increased from four in 2023-24 to six in 2024-25 and eight in 2025-26. 

In other words, there is evidence of increasing fiscal stress in state finances across states. The need for fiscal consolidation is back on the cards. The options are, as always, augmenting revenues and/or restructuring expenditures. There are two thoughts on this count. First, there are exceptions to this broad phenomenon of emerging fiscal risk. Some states have been able to consistently maintain revenue surpluses — these include Gujarat, Jharkhand, Madhya Pradesh, Odisha and Uttar Pradesh. These include high income and middle-income states, mineral-rich states as well as states dependent on the agricultural sector. On the other hand, Haryana, Maharashtra and Rajasthan report consistently good revenue performance with growth in revenues close to or over 10 per cent. Some sharing of experiences might be useful. 

Second, while the big-picture questions on state finances have been flagged in white papers, one emerging concern seems to have been missed. Macroeconomic conditions in the economy are raising certain concerns, the foremost among them being the challenge in generating an adequate number of productive jobs. Technological change seems to suggest a further exacerbation of this challenge. In this context, there is a shift in policy in favour of expanded welfare programmes. These range from income supplements, to free food, to free electricity and transport as well as health care. While each of these is a worthy cause in and of itself, these initiatives imply a fiscal cost. One question that could have been asked is whether there could and/or should be a framework on the scale and composition of such schemes. This could be an important element in any proposed restructuring of expenditures.

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The author is director, National Institute of Public Finance and Policy. The views are personal