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In India, there is much ado about the Union budget each year. News channels are agog weeks in advance and analysts and commentators are lined up to dissect and opine before, during and after the budget speech is delivered by the finance minister. And then everyone loses interest, until the circus repeats the following year. The finance and appropriation Bills for 2015-16 were passed last week in the Lok Sabha, without creating too much of a media flutter.

The Union budget for 2015-16 was markedly different from ones in the past because it accepted the recommendation of the 14th Finance Commission to devolve a greater percentage of central taxes directly to the states. In what Prime Minister Narendra Modi calls “cooperative federalism", states will receive an additional sum of money this year, representing 42% of central taxes and a 10% jump from prior years.

In this fast federalizing India, few are aware about the budget-making process in the states and fewer still know about the relative magnitude and priorities to different issues at the state level. The states themselves seem to be waking up only slowly to this greater devolution and its corollary implication that many central government schemes will be drastically pruned at the state level and states will have to substitute both capacity and money to rapidly fill the gaps.

First, the facts. It may come as a surprise to many that over the last 10 years, state finances have actually improved. In contrast, Union finances first improved until 2007-08 and then sharply deteriorated. In aggregate, gross fiscal deficits at the state level relative to gross domestic product (GDP) have come down by about 1.4% and primary deficits by about 0.2%. These fiscal improvements have come about primarily because of an improvement in revenue receipts (better and higher tax collection) and a slight reduction in capital expenditure (obviously not sustainable in areas where infrastructure is poor). To a lesser extent, the improvement is also because aggregate outstanding debt and liabilities at the state level have come down over these 10 years.

Many states in India now have an annual budget that exceeds 1 trillion: Maharashtra, Gujarat, Madhya Pradesh, Bihar, West Bengal and Tamil Nadu among others. Uttar Pradesh is the country’s largest at over 3 trillion. Tamil Nadu, Gujarat, Madhya Pradesh, Maharashtra are revenue neutral or run small revenue surpluses (annual income exceeds expenditure). The northeastern states run large revenue surpluses mostly on account of transfers from the Union. Kerala, Punjab and West Bengal have run revenue deficits over many years. The debt burden of states also varies widely from a low of about 15% of state GDP (GSDP) for Chhattisgarh and 19% for Maharashtra to nearly 50% for Jammu and Kashmir and the northeastern states. The median figure of debt to GSDP is about 21%. As a consequence, state fiscal deficits range from a low about 2% for Maharashtra to a high of about 4% for the northeastern states and Goa and 5% for Telangana.

This diversity in state finances sets up very different priorities at the level of each state. Any state with a revenue deficit and a high debt burden (Kerala or West Bengal for instance) is constrained by both current resources and future resources (borrowings from the centre). Those whose debt burdens are low (Maharashtra or Odisha for instance) may choose to borrow more, but with the careful consideration that this is for productive investment. All states will need to continue to focus on broadening the tax base, reducing leakage and enforcing fair but rigorous collection. Subsidies will have to be more specifically targeted and with fewer leakages.

The state budget speeches contain measures from the sublime to the ridiculous. Many of the speeches are adorned with couplets and snippets of poetry from the concerned finance minister’s favourite poet. The Dharmashastras, Kabir and Thiruvalluvar are popular.

Most states improve their revenue by increasing taxes on sin and petroleum. Karnataka for instance raised taxes this year on “Indian made foreign liquor" (IMFL), a quaint term for non-local varieties of booze, by about 13%, value added taxes (VAT) on petrol and diesel by 1%, and cigarettes, cigars and gutka by 3%. To attract refuelling in the state, Madhya Pradesh reduced its VAT on aviation gasoline but increased licence fees on pistols and revolvers and VAT on tobacco free paan. This year’s budget for the newly bifurcated state of Andhra Pradesh incorporates a Vision 2029 document that says the state will become the world’s best investment destination by 2050!

In the years to come, state finances both at the aggregate level but also in detail will come into much greater scrutiny. Twenty-nine state finance ministers acting on behalf of their chief ministers will become more important than one Union finance minister. The capacity of the states to improve their revenue, set their budgets with care and optimize their expenditures and borrowings will be tested.

The circus will move from Delhi to your town.

P.S. “All know that the drop merges into the ocean, few know that the ocean merges into a drop", said Kabir Das.

Narayan Ramachandran is chairman, InKlude Labs.

Comments are welcome at narayan@livemint.com. To read Narayan Ramachandran’s previous columns, go to www.livemint.com/avisiblehand

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