India must confront the fiscal risks of an expanding freebie culture

As subsidies and cash transfers surge, the Supreme Court and Finance Commission warn that unchecked freebies risk straining state finances and long-term growth

The Supreme Court last week expressed displeasure over the growing culture of freebies. The court’s concern is understandable, and needs a collective response from the Union and state governments. While hearing a matter related to Tamil Nadu Power Distribution Corporation, Chief Justice of India Surya Kant noted that unchecked distribution of largesse could weaken the economic foundations of the country. This is important because many states are running a revenue deficit, which effectively means they are borrowing to fund subsidies or simply distributing cash under one scheme or another. The Bench also noted that announcements of such schemes frequently took place before elections. Notably, the court acknowledged that the state had an obligation to help those who lacked access to essential services such as education and utilities, but they should be well targeted. 

The 16th Finance Commission has also discussed this issue at length while underscoring the implications for public finance. An analysis of 21 states by the Finance Commission showed that their subsidies and transfers were budgeted at ₹9.73 trillion in 2025-26, as against ₹3.86 trillion in 2018-19. As a percentage of the combined gross state domestic product (GSDP) of the 21 states, the outlay on subsidies rose to 2.7 per cent in 2023-24 from 2.2 per cent in 2018-19. Unconditional cash transfers are budgeted at nearly ₹2 trillion in the current year. They account for a 20 per cent share in schemes for subsidies and transfers of states. The biggest component remains power subsidy — at 27 per cent. The power-subsidy bill for 2023-24 was ₹2.60 trillion. However, it must be noted that the bill understates the subsidies provided by the states. Part of it is on the books of state power-distribution companies, which is reflected in their accumulated losses and debt. Besides the state governments, the Centre also provides various kinds of subsidies. The allocation increased during the pandemic, but moderated in the following years and is budgeted at 1.76 per cent of gross domestic product (GDP) this financial year. The bulk of the subsidy allocation goes for food and fertilisers. 

As the Finance Commission also noted in its report, it is worrying that, once implemented, a subsidy or cash-transfer scheme remains in effect permanently. Given that a substantial amount of general government expenditure goes in subsidies, particularly at a time when public debt is at an elevated level of about 80 per cent of GDP, there is a need for a national debate on the subject. In a competitive political environment, incumbents are often inclined to keep increasing the level of subsidies and cash transfers. Thus, it is necessary to have hard fiscal rules and mechanisms need to be devised to keep the general government finances on a sustainable path. 

There are several issues here. First, there is a need to define merit and non-merit subsidies. Second, clear limits on states’ expenditure on subsidies and cash transfers are needed, particularly for those states running a revenue deficit and carrying a higher debt burden. Third, India needs a consensus as to how much of general government spending should go into financing subsidies and cash transfers. This is critical because higher government spending on subsidies constrains fiscal capacity, and higher borrowing requirements tend to crowd out private investment. Sustained higher spending on subsidies will directly affect longer-term growth prospects.