The crisis in state spending

Far from empowering the poor, the proliferation of freebies could have the opposite effect, harming social and economic outcomes

- M GOVINDA RAO

In Indian fiscal federalism, states have the predominant responsibility for providing social services and share coequal responsibility, along with the Union government, for economic services.

Yet, when it comes to evaluating their fiscal performance, the focus invariably remains on their deficits and debt, and not on the quality of their public spending. In reality, the recent trends see a sharp deterioration in the quality of public spending as subsidies and transfers crowd out expenditures on empowering people and accelerating development. Every political party promises more and more “freebies” for short-term electoral gains, thereby compressing expenditures on physical and human capital.

Surely, controlling deficits and debt are important for sustainable fiscal management. However, the basic premise of the decentralisation theorem is that macroeconomic stabilisation and redistribution are predominantly (not exclusively) Central functions. The founding fathers of the Constitution were aware of this and, therefore, placed a mechanism to restrict states’ borrowing. Article 293 (3) requires states to seek the permission of the Union government if they are indebted to it. Although the Twelfth Finance Commission emphasised the need for the Union government to move away from inter-mediation, it has continued to do so — the latest example being the long-term Union loan for capital expenditures advanced to the states at zero rate of interest. With the fiscal responsibility legislation fixing their fiscal deficit at 3 per cent of gross state domestic product or GSDP, the Union government is supposed to place the limit. Of course, some states exert pressure to expand the deficit envelope through off-budget borrowings, but the responsibility to enforce the limit squarely lies with the Union government.