Containing subsidies: Why states must reassess and rationalise expenditure

Doing so, especially given their constrained fiscal space, would help states ensure the subsidies are better aligned with their intended objectives and public funds are used more efficiently

Subsidies in India are frequently used as a tool for welfare and social support. Their utilisation, necessity, and long-term viability have been the subject of considerable debate over the years. However, in the context of the country’s higher general government debt and constrained fiscal space, rationalisation of subsidies has become crucial. In this regard, a recent study conducted by the National Institute of Public Finance and Policy, titled “Rationalisation of Explicit Subsidies at State Level”, highlighted the critical importance of state governments in managing their expenditures more effectively. The study emphasised two significant trends in state finances that have emerged following the pandemic. First, states’ revenue has experienced considerable volatility since the pandemic. Second, the fiscal space available to states has become increasingly constrained. For instance, between 2016 and 2022, Punjab’s debt increased by 44.23 per cent and is currently at 45 per cent of state gross domestic product.

One of the primary reasons for this limitation in fiscal space for states is the implementation of goods and services tax (GST), which has significantly reduced the residual taxing authority of state governments. As a result, states have only a marginal scope to generate additional tax revenues, with most states already exploiting these limited avenues to their full potential. Additionally, a substantial portion of state Budgets goes towards committed expenditures, including essential services like education and health care, as well as salaries and administrative costs. These services, combined with obligatory interest payments, dominate state Budgets, leaving little room for discretionary spending. From 2017 to 2020, the share of committed expenditures for most states ranged between 60 per cent and 80 per cent of their expenditures. Consequently, the amount of “untied” expenditure available to states is minimal. Within this already limited untied expenditure, explicit subsidies pose a particularly heavy burden on state finances. These subsidies, which include direct financial support, insurance payments, scholarships, and assistance to public-sector units, consume a substantial portion of states’ discretionary Budgets.

Thus, the constraints on both revenue generation and expenditure flexibility underline the importance of deft financial management. The case studies of seven states in the report reveal common issues contributing to the significant amounts of explicit subsidies. These issues include poor targeting of subsidies, lack of transparency, substantial debt relief granted to farmers, free power supply that has pushed state electricity boards into debt traps, and interest subsidies on loans. These challenges are prevalent across all states. It was estimated that explicit subsidies in a few states, such as Punjab, Rajasthan, and West Bengal, were above 20 per cent of revenue expenditure.

Relying on borrowing to finance these explicit subsidies is not a sustainable strategy in the long term because it severely diminishes the resources available for crucial infrastructure development and investment and hampers economic growth. Therefore, it is imperative to enhance the fiscal space by carefully reassessing and rationalising subsidies. By doing so, state governments can ensure that the subsidies are better aligned with their intended objectives and public funds are used more efficiently. Sustained fiscal pressure in some states also highlights the need to rationalise GST rates and slabs quickly. Higher revenue will augment fiscal capacity at both Union and state levels.