ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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State Budgets: Enhancing Social Spending

After a sharp and prolonged downturn in the finances of state governments in the late 1990s, the fiscal correction that began in the year 2004 is now being further consolidated. Greater tax devolution and incentivisation on part of the Twelfth Finance Commission, enactment of fiscal responsibility legislation, improved revenue collection due to the adoption of VAT by nearly all states and the retirement of high-cost debt under the Debt Swap Scheme floated by the centre have led states to exercise fiscal restraint. According to the RBI’s annual State Finances: A Study of Budgets of 2006-07, key fiscal indicators for the year 2005-06 show a marked improvement from the previous year: the consolidated gross fiscal deficit (GFD) for the states was reigned in at 3.2 per cent of GDP versus 3.5 per cent last year, owing to a sharp decline in the revenue deficit (RD) from 1.2 to 0.5 per cent of GDP. The reduction in RD has come about mainly by a 22 per cent improvement in revenue receipts over the previous year, as states both mobilised greater own tax revenues and received a higher share of taxes and grants from the centre. This stands in contrast to the fiscal correction achieved on account of the compression of developmental expenditure in 2004-05 and is a salutary development. The states also curbed non-development expenditure in 2004-05 while total capital outlay rose by 39 per cent over the previous year.

One of the most important budgetary functions of the states is to undertake developmental expenditures on behalf of their citizens, including but not limited to spending on health, education, water supply, rural development and housing. (These developmental or social sector expenditures (SSE) are classified under the budget heads of social and economic services for the purpose of accounting.) Fiscal correction presents states with the opportunity to invest in flagging social services and reverse the secular decline of developmental expenditure established through the 1990s. The low fiscal priority accorded to developmental spending by the states is visible in the ratio of SSE to total expenditure, which dropped to 29.7 per cent in 2004-05 after hovering in the region of 37 per cent on average in the 1990s. Moreover, the long-term trend of poor capital outlays for the social sector – no doubt one of the reasons for the lack of adequate social infrastructure in the country – is another important issue. In 1990-2005, a mere 8 per cent of the aggregate expenditure on the social sector went towards capital formation though there have been efforts since then to step up capital spending in this area – in 2005-06, it comprised 10.1 per cent of total developmental expenditure. The budgetary goal is to shift the composition of the GFD towards capital outlays: the decomposition of GFD for 2006-07 estimates that 88 per cent of this deficit will be accounted for by capital outlays while a mere 4.1 per cent will go towards the RD. While this is a laudable goal, the thrust on creating physical rather than social infrastructure appears to be a matter of greater priority for states, a rather unfortunate state of affairs.

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