The Precarious Shape of State Finances

The Imposition of Nation-Wide Lockdown has Paralyzed State Finances as well as Undermined Cooperative Federalism

The Precarious Shape of State Finances
The Precarious Shape of State Finances

A few weeks ago, the Goods and Service Tax (GST) compensation dues to states for 2019-20 was released by the Central government. Due to economic slowdown, the compensation amount was more than the double of what was paid in the previous financial year. The total compensation released was ₹ 1,65,302 crore while the compensation cess fund collected was ₹95,444 crore. The excess collections of previous years and the balance of inter-state GST from past years helped in making up the deficit. This raises a vital question of how compensation will be made in current year.


The corona crisis has brought the financial health of the country into limelight as never before. There has been a drastic decline the States’ revenue sources which has increased their dependency on the Centre. While a part of the dependency of states in due to the inherent fiscal structure, it has been exacerbated due to the GST. The article highlights the precarious condition of the state finances amid corona crisis, the present financial challenges being faced by the states and how states could have dealt with this crisis in pre-GST era or in pre-decentralised era.

The Present Scenario

The corona crisis has brought the financial health of the country into limelight as never before. In April 2020, an unprecedented revenue shock hit the states when nationwide lockdown was announced by the Central government in response to COVID-19 pandemic. More than 60% of all economic activities came to a halt without any prior notice. The fall in revenue inflows were so drastic that some states like Odisha, Telangana, Andhra Pradesh and Rajasthan were forced to defer a portion of salaries of government staffs and minister. Even states like Kerala and Maharashtra were forced to announce cuts that would last for a few months. The government of Karnataka was forced to hold an emergency sale of corner plots in Bengaluru for acquiring funds.

The fiscal environment of the states was already facing several challenges before the COVID-19 was declared a pandemic due to economic slowdown. Dependency of states on centre has increased as revenue of states have decreased from 55% in 2014-15 to 50.5% in 2020-21. Even though some part of the dependency is due to the inherent fiscal structure, introduction of GST has exacerbated the condition. The GST regime provides that the centre disburses a GST compensation if tax collection falls below a growth rate of 14% for state GST.  However, the actual devolved taxes have remained consistently lower than what was projected by the 14th Finance Commission. In the current situation, the fiscal problems have increased for the states due to the burden of COVID-19. The GST collection in June 2020 was ₹90,917 crore which dropped to ₹87, 422 Crore in July when compared to July 2019, the figure stood at ₹ 1.02 lakh crore. According to experts, after the brief spike in June 2020, which was the result of lockdown induced pent-up demand, the economic revival started plateauing in July. Ms Sitharaman, the Finance Minister, herself said, “the government is cautious about overstating the green shoots of a recovery visible in the economy”.

The conditions of the states became even more precarious after announcement of nation-wide lockdown because most of the state taxes (mainly GST) accrue from ‘non-essentials’, the revenue implications were serious indeed. States’ tax collections were seen to be reduced by more than 40% in April 2020. It is true that brunt of losses was even borne by the Centre, but it also has alternatives like income tax, custom duty and corporate tax which continued during the lockdown. In contrast, since almost 40% of the GST revenues of the Centre are shared with the states, it was the states that actually bore the significant part of the decline. Revenues for the states sharply dropped at the point when their expenses largely shot up.

A Triple Blow

It’s clear that financially broken State governments adopted desperate measures like opening liquor shops for mobilising funds to stand against the coronavirus crisis. The question here comes up, even if they’re strapped for funds, there must also be some other alternatives of raising funds other than preying on people’s alcohol addiction for saving lives. Therein lies the rub.

The dependency of states on centre drastically increased from the midnight of 1st July 2017, when Goods and Service Tax regime was launched by Prime Minister Narendra Modi. The State governments got stuck to the centre’s neck forever. Good and Service Tax compelled the State governments to surrender their powers of independently raising resources through local state taxes and place them completely at the mercy of the Centre to get most of their financial demands.

Hence, in this GST regime, majority of the States raises their funds through a combination of a share in Centre’s taxes and their own taxes. In case of richer states like Maharashtra, Delhi, Gujarat, Tamil Nadu, Haryana, Kerala, Karnataka and Punjab, more than 70% of their revenues are collected from taxes generated from within their state boundaries. A half of these comes from excise duties on petrol, alcohol, electricity, land registration fees etc. while the other half mainly comes from the sale of goods and services within State boundaries. In pre-GST regime, states were allowed to charge sales taxes legislated by their State legislatures. For instance, in case of a natural disaster, the affected state had the authority of raising additional funds for rehabilitation by increasing rate of sales tax on goods and services.

Thus, it can be concluded that in the interest of GST, fiscal powers were sacrificed by the states in the promise of ‘tax buoyancy’ and ‘economic efficiency’ which never happened. As per GST, States are entitled to their own share of tax revenues accumulated within their own State. But currently the states remain reliant on centre for periodical disbursement of these funds. At the time of GST enactment, it was guaranteed that for coming five years states will receive a minimum tax revenue every year. However, amidst the present corona crisis, the Centre has reneged on both these promises.

On summing up the issues, its actually a triple blow for the States – bearing the brunt of the pandemic’s impact, neither being aided with additional resources nor being paid what they are owed. To add to the woes of the states, not only they are not receiving their payments that is rightfully due to them, but also their authority of raising funds through sales tax are also lost. According to survey conducted by Centre for Policy Research, there is a gap of ₹6.84 lakh crore between what was promised to the states by 14th Finance Commission and what was actually disbursed to the states. So, with no financial resources or support, it was a severe challenge for the states to continue their fight against the health calamity.

As already mentioned earlier, sale of petroleum products, lottery tickets, electricity, alcohol, land and vehicle registration are some of the alternatives that the states use for raising fiscal resources. But the extreme lockdown had dwindled the demand for land, vehicles, lottery tickets and petroleum products. As joblessness increased and citizens faced financial crunch, the option of electricity for raising funds also became obsolete. Hence, the states were left with only one option for raising the funds – sale of alcohol. Alcohol sales account for more than one-third of the State tax revenue for the larger and richer states. It could be argued that consumption of alcohol potentially increased during the lockdown period and hence States were tempted and coerced to resort to raising monies from alcohol habits of individuals. Ironically, the States were forced to rely on a health problem for resolving a health crisis.

Here arises the next question. Can’t the States borrow money to tide over this crisis? In short, the answer in ‘no’. This is because, to stand as a guarantor or increasing the borrowing limits, the states needs to have approval from the Centre. As there are no clear revenue visibility of the states, their borrowing rates remains very high and their ability to borrow is severely undermined. Hence, the states again become dependent on the Centre for borrowing capital from the market and then distribute them to the States.

To add further to the woes of the state, the PM- CARES fund, a non-auditable, opaque and discretionary fund, was made eligible for use of Corporate Social Responsibility (CSR) expenses of corporates. This provision was not extended to the Chief Minister’s relief fund that the states uses to meets humanitarian needs. Hence, the corporates are debarred by centrally imposed rule from supporting the states even if they wished to.

In pre-GST era

If this pandemic situation would have had erupted in the pre GST era, then the states would had the option of raising the funds through sales taxes and not had to depend so much on the Centre’s mercy for release of funds. Secondly, an option of increasing taxes on selected essential goods within State boundaries (such as mangoes or coconut oil) would remain open in accordance with their norms. Since it is the state governments that stands in the frontline in this battle against corona crisis, a decentralised manner of administration might had been more fruitful because then the states could had been able to raise the required resources needed to fight this disease locally and remain dependent on the whimsical magnanimity of the central government.


As COVID-19 cases continues to increase and several parts of the country undergoes intermittent lockdowns, the economic challenge created due to the pandemic worsens and gets difficult. Unemployment rate is high; demand continues to be low; supply chains remain disrupted; and centre’s budgetary equations may not hold revenue deficits and new expenditure commitments. Some of the complex challenges will be loan-default related issues in the financial sector once the ongoing moratorium comes to an end. Any catastrophe on this front will demand a bailout and also inflict another strain on the already stretched fiscal resources of the government. A sudden withdrawal relief may trigger inflammatory shock as productive capacity suffers. Thus, it will be interesting to see what decision Reserve Bank of India’s Monetary Policy Committee takes in the August meeting. Whatever it is, from the above discussion it is thus clear the state government finance will be in shambles when all the smoke and dust clears and they will be left with no other choice but to approach the central government with begging bowls in hands to continue their day-to-day activities.


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