On paper, the GST era has been a success for state finances. States’ Own Tax Revenue (SOTR), powered by GST inflows, made up nearly half of total revenue receipts in FY23. The tax’s buoyancy — 1.4 in FY23 — meant collections grew faster than the economy itself. Large consumption-heavy states such as Maharashtra, Tamil Nadu and Karnataka have clearly benefited, raising over 60% of their revenues from their own taxes.

But beneath the numbers lurks a structural asymmetry. States with smaller consumption bases — the North-East, Bihar, Himachal Pradesh — raised less than 40% of their revenues from own sources. For them, GST has not been the great equaliser it was once promised to be. Instead, these states remain hooked on tax devolution and central grants, perpetuating fiscal dependency.

For five years after GST’s introduction, the Centre sweetened the deal with a compensation mechanism that cushioned states against revenue losses. When the pandemic struck, back-to-back loans replaced grants to keep the system afloat. That era is over. Compensation ended in June 2022, and the loans have only added to states’ debt stock.

The CAG report makes clear the fallout: Punjab, Kerala and West Bengal — among the most vocal critics of GST design — have seen their fiscal gaps widen sharply post-compensation. Punjab’s liabilities are now a staggering 45% of GSDP. Kerala, struggling with high pensions and social sector spending, slipped deeper into deficit despite buoyant GST. Without compensation, states are discovering that GST alone cannot rescue weak tax bases or cover years of populist profligacy.

The XV Finance Commission set a 3.5% ceiling on state fiscal deficits. In FY23, 12 states breached it. Himachal Pradesh (-6.5%), Assam (-6.3%), Bihar (-6%) and Punjab (-4.9%) are only the most conspicuous violators.

Why do these breaches persist, year after year? The answer lies not in revenue weakness alone but in political economy. States locked in competitive populism are unwilling to rein in subsidies. Loan waivers for farmers, free power, and social welfare doles have become electoral currencies. In election years, the impulse to overspend becomes irresistible. Fiscal consolidation, meanwhile, is kicked down the road.

This is not accidental slippage. It is political choice. Parties calculate that voters reward immediate consumption transfers more than long-term investment in schools, hospitals or roads. The fiscal deficit thus becomes the hidden cost of electoral survival.

One of the most damning insights in the CAG report is that in at least 11 states, capital spending was lower than net borrowings. In Andhra Pradesh, just 17% of loans funded capital outlays; the rest vanished into revenue expenditure. Punjab and West Bengal tell similar stories.

This violates the “golden rule” of public finance: governments should borrow to build, not to consume. Instead, states are piling up debt not for tomorrow’s infrastructure but for today’s bills — salaries, pensions, and subsidies. The long-term consequence is brutal. Every rupee borrowed to fund consumption shrinks the fiscal space for future investment, trapping states in a cycle of debt rollovers.

Subsidies consumed nearly 9% of revenue expenditure in FY23, but their distribution reveals a deeper story. In agriculture-heavy states such as Punjab and Andhra Pradesh, power subsidies alone run into tens of thousands of crores. In Tamil Nadu, free rice and social transfers dominate. In Karnataka, the new guarantee schemes — free bus travel for women, enhanced social welfare — are already testing fiscal limits.

These policies may have social justifications, but they come at a cost. Subsidies are notoriously sticky; once granted, they are politically suicidal to roll back. They also distort incentives: free power, for instance, encourages groundwater over-extraction, worsening ecological stress. Yet governments persist, because subsidies win votes today while debt burdens fall on future generations.

Beyond subsidies, the biggest fiscal albatross is committed expenditure — salaries, pensions, interest payments — which accounted for 43.5% of revenue spending in FY23. For Nagaland, this was 74%. For Maharashtra, it was 32%.

This rigidity leaves policymakers with little flexibility. When more than half of revenues are pre-committed, the scope for discretionary development spending shrinks dramatically. The politics of public sector employment and pension promises ensures that no party seriously attempts reform. Indexation of pensions, periodic pay commission awards, and electoral pledges to expand government jobs keep the wage and pension bill rising inexorably.

On top of direct debt, states carried guarantees worth ₹10.1 trillion — 3.9% of GSDP — in FY23. These cover loans taken by state enterprises, many of which are financially distressed. If defaults materialise, states will be forced to absorb the liabilities, further inflating deficits. Yet guarantees attract scant scrutiny in public debate, making them a hidden fiscal iceberg.

The report also reopens an uncomfortable question: does the current federal fiscal architecture adequately balance the needs of states? GST has strengthened tax collection overall but accentuated disparities between high-consumption and low-consumption states. Union transfers are supposed to bridge this gap, but they come with political strings. Centrally Sponsored Schemes dictate priorities from Delhi, reducing state autonomy. Meanwhile, poorer states slip further into dependency, with little incentive to reform or mobilise their own resources.

What then is the way forward? First, fiscal responsibility frameworks cannot remain toothless. Breaches of deficit and debt ceilings must carry consequences, whether in reduced borrowing limits or stricter conditionalities on transfers. Otherwise, the rules are no more than paper.

Second, states must confront the subsidy dilemma. A more targeted, transparent approach — using direct benefit transfers rather than blanket giveaways — could reduce leakages and free up fiscal space. Political parties, however, must find the courage to move beyond the freebie economy, a task easier said than done in the heat of competitive populism.

Third, structural reform of pensions and public employment is unavoidable. Unless states address the pension explosion — perhaps through gradual migration to defined-contribution schemes — they will find themselves trapped in a fiscal straightjacket.

Finally, the Union must revisit the devolution formula in light of the GST experience. If poorer states are perpetually locked into dependency, the promise of fiscal federalism remains hollow. The 16th Finance Commission, due in 2026, will need to grapple with these contradictions head-on.

The State Finances 2022–23 report is not just an audit of numbers; it is an x-ray of India’s political economy. It reveals how the compulsions of electoral politics — the pressure to subsidise, to employ, to promise — collide with the discipline of public finance.

The tragedy is that debt can be productive if it builds assets, but destructive if it feeds only salaries and subsidies. Too many states are choosing the latter path. By mortgaging the future to pay for the present, they risk leaving the next generation not schools and hospitals, but debt and deficits.

The time for fiscal prudence is not after elections, not when crisis looms, but now. Without it, India’s states will continue to live in a fiscal illusion — rich in rhetoric, poor in reality. (IPA Service)