Municipal in nature, reckless in desire and quite often a source of difficult problems, state finances are in news again. After almost seven odd years of tranquillity, state deficits are set to reappear.
This year, the growth in states’ tax revenues and resources handed out by the Centre is expected to slow. With the Centre’s “true” fiscal deficit touching 8% of gross domestic product (GDP), the ability of the Centre to feed the states is quite limited. At the same time, expenditures are expected to continue as usual. By one estimate, a 4% shortfall in their budgeted revenue for 2008-09 is likely to wipe out the surpluses accumulated by the states. In 2007-08, 28 states had a revenue surplus of Rs22,500 crore—a remarkable turnaround from a deficit of Rs63,400 crore barely four years earlier in 2003-04. These years are anomalous compared with the trend. 2006-07 was the first year since 1987-88 that states witnessed a revenue surplus.
What are the sources of the problem? On the revenue side, slower economic growth is likely to result in lower value-added tax (VAT) receipts. VAT contributes nearly 42% to the states’ tax kitty. Slower industrial growth and a weak realty sector, too, will exact a price. State excise, stamp and registration duties, together accounting for around 17% of revenue, will also be hit.
On the expenditure side, the Sixth Pay Commission award is likely to add 0.5% of GDP to the fiscal deficit figure. In one way, the burden on this count is much less compared with the situation that prevailed when the Fifth Pay Commission award was implemented. That added 1.5% of GDP to the fiscal deficit figure. What complicates things is that when combined with heavy expenditure by the Centre, slow economic growth and higher salaries have the potential to make the combined fiscal deficit figure touch the 10% of GDP mark. In contrast, the “official” fiscal deficit figure still hovers around 2.5% of GDP.
This being an election season, the urge to spend more than what states have is likely to prove irresistible. Already, there are calls for “suspending” the Fiscal Responsibility and Budget Management (FRBM) Act. It’s not surprising that these calls are being made by some states that are in bad fiscal shape. Kerala’s finance minister, T.M. Thomas Isaac has been making this demand for some time. Greater “financial resources”, a thinly divided argument against the FRBM Act, was also heard at the meeting of the empowered committee of state finance ministers in early November. Kerala, West Bengal and Punjab were at the forefront of this demand. No marks for guessing the identity of states with poor finances.
How can states finances be set right? Tell us at firstname.lastname@example.org