SHOULD STATES THAT SPEND IRRESPONSIBLY BE PENALISED?

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Context:

States that spend irresponsibly should be penalized to promote fiscal discipline and reduce dependency on blanket government guarantees.

Fiscal Relations between the Union and States  

Division of taxing powers under the Constitution 

1. Union List (Schedule VII); Taxes on income (except agricultural income), customs duties, excise duties on tobacco, and other goods, taxes on corporate profits, and goods and services tax (GST) on interstate trade.
2. State List: Taxes on agricultural income, land and buildings, excise on alcohol, taxes on vehicles, and state-level GST.
3. Concurrent List: Includes taxes like stamp duties and property taxes, but the Union has overriding powers in case of conflicts.

The Union collects many taxes but shares a portion with the states

1. Every five years, the President of India constitutes a Finance Commission to recommend the distribution of taxes between the Union and the states and among the states themselves.
2. The Finance Commission recommends the percentage of central taxes to be devolved to the states. The 15th Finance Commission recommended that 41% of the divisible pool of taxes should go to the states (2021–26 period).

The Union government provides grants to states in two major forms:

1. Statutory Grants (Article 275) are given to states based on recommendations of the Finance Commission. States needing special assistance due to inadequate revenues may receive such grants.
2. Discretionary Grants (Article 282) are grants for specific purposes (like disaster relief or centrally sponsored schemes) where the Union government has discretion in allocation.

The Union and the states have borrowing powers with certain restrictions:

1. The Union can borrow on the security of the Consolidated Fund of India.
2. States can borrow only within India and require the Union government's approval if they have outstanding loans with the Union.

Trends in state finances based on the Budget Estimates for 2023-24

1. States’ Own Revenue comprising tax and non-tax sources account for 57% of total revenue receipts. Central Transfers including devolution of central taxes and grants from the Centre contribute 43%.  States such as Bihar, Jammu and Kashmir, and those in the northeast raise more than 60% of their revenue from central transfers.   
2. The overall own tax-to-GSDP ratio for states is around 7%, indicating states' low capacity to generate revenue from economic activities. Certain states, especially in the northeast, have lower ratios (3% to 4.2%). 
3. Revenue Expenditure accounts for nearly 83% of total state expenditure, a revenue deficit occurs when a state's revenue expenditure surpasses its revenue receipts, necessitating borrowing to cover expenses that do not result in asset creation. 
4. The fiscal deficit represents the gap between a state's total expenditure and its total revenue. The aggregate fiscal deficit for states is about 3.1% of GSDP, however, the 15th Finance Commission recommended a fiscal deficit limit of 3% of GSDP. 
5. Outstanding liabilities encompass the debt accumulated from past borrowings, alongside other liabilities from public accounts. As of March 2023, outstanding liabilities are nearly 29.5% of GSDP.  Liabilities have risen from 22% of GSDP in 2013-14, emphasizing the growing financial pressures on states.

Challenges in Union-State Fiscal Relations Disparities in Tax Collection; States with higher economic activity (like Maharashtra, Gujarat) collect more revenue, creating disparities with smaller or economically weaker states. Dependence on Central Transfers; Many states, especially in the northeast and less-developed regions, are heavily dependent on central transfers and grants. Tensions over GST Compensation; States have expressed concerns about delays in receiving compensation under the GST regime.

What is Irresponsible spending?

When states spend irresponsibly, they may end up with financial problems; not being able to pay salaries or bills on time. The present situation shows that even states in bad financial shape can borrow money at low interest rates, just like states that manage their money well.

Case Study In 1975, New York City was in big financial trouble. The U.S. government at first refused to help, telling the city to "put its house in order." Only after showing some effort to fix things did New York get a loan from the government.

Consequences of Irresponsible Spending

Economic Impact

1. High levels of debt increase interest payments, which take a substantial portion of the budget, reducing funds available for development and essential services.
2. Extreme debt can lead to downgrades in credit ratings, increasing borrowing costs and reducing investor confidence.
3. To manage high debt levels, governments may need to cut spending on essential services (like healthcare, education, and infrastructure); leading to a decline in the quality and availability of public services, affecting overall societal well-being.

Social Impact

1. Reduced public services disproportionately affect lower-income and vulnerable populations, increasing social inequality. Economic disparities and reduced access to essential services can lead to social unrest and instability.
2. Lack of accountability and transparency in spending erodes public trust in government institutions, irresponsible spending correlates with higher levels of corruption.
3. High levels of debt can impose a significant burden on future generations, limiting their economic opportunities and fiscal flexibility. 
4. Allocation of resources towards unsustainable projects can lead to long-term environmental damage, affecting quality of life.

Arguments in favour of imposing the Penalty

1. Penalties act as a deterrent against reckless financial practices, encouraging states to adhere to budgetary constraints and prioritize essential expenditures.
2. Penalties will encourage states to maintain fiscal discipline, avoiding unnecessary debt and wasteful expenditures.
3. It will influence the state government to efficiently use resources; focus on projects that provide significant public benefits, and economic growth and ensure sustainable development.
4. Ensuring responsible spending helps maintain the overall fiscal health of the nation, a disciplined fiscal approach enhances investor confidence, attracting more investments and fostering economic development.

Arguments against Imposing Penalty

1. Recognizes that external factors like natural disasters, economic downturns, or pandemics can lead to increased spending. Penalizing states in such situations may be unfair and counterproductive.
2. Penalties may aggravate financial issues, leading to additional cuts in essential services like healthcare, education, and infrastructure.
3. It can undermine the autonomy of states, leading to tensions between the central and state governments and affecting cooperative federalism.
4. Helping states to improve their fiscal management through support and capacity building rather than punitive measures; providing incentives for responsible spending can be more effective than penalties.  

Way Forward

• India should move towards market-determined pricing of state debt; states with poor financial health have to pay higher interest rates to borrow money. This could incentivize states to improve their fiscal position.
• States should be held accountable for their spending. If states had to pay higher interest rates when they borrow a lot, they might be more careful with their money. This is what’s called “market discipline".
• States need to take steps to improve their fiscal discipline; reducing subsidies, increasing revenue through taxation or other means, and improving the efficiency of government services.  

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IMPACT OF EMERGENCY PROVISIONS ON CENTER-STATE RELATIONS

Source: 

Indian Express

PRS

PRACTICE QUESTION Q.Critically analyze the current system of fiscal federalism in India. Discuss the balance between central control and state independence, and suggest reforms to enhance state fiscal autonomy.  (250 Words)