Reference Article: Editorial | The Hindu – Devolution, not debt: On the rapid expansion of State Development Loans
UPSC Relevance:
GS Paper III – Indian Economy (Fiscal Federalism, Public Finance, State Finances)
GS Paper II – Centre–State Relations, Federalism
While States closely track Union Budgets for tax devolution, this channel is no longer the fiscal stabiliser it once was. Despite the 15th Finance Commission fixing States’ share at 41% of the divisible pool, the growing reliance of the Centre on cesses and surcharges — which are outside the divisible pool — has weakened the effective flow of resources to States.
State Development Loans as a New Shock Absorber
- State Development Loans (SDLs) have become central to financing routine expenditure
- In 2024–25 (RE), SDLs formed about 35% of Tamil Nadu’s revenue receipts and nearly 26% of Maharashtra’s
- Such levels of borrowing would have been fiscally exceptional a decade ago
- The trend accelerated after the COVID-19 shock, when Central devolution proved insufficient
Structural Pressures after GST
- GST centralised indirect tax collection, diluting the fiscal link between States’ tax effort and rewards
- Industrialised States with strong indirect tax bases are particularly affected
- Welfare obligations — pensions, health insurance schemes — are increasingly financed through borrowing rather than assured revenues
Evidence from State Borrowing Patterns
- Even States heavily dependent on Central transfers, such as West Bengal, continue to borrow extensively
- Over the past five years, West Bengal derived nearly 47.7% of its revenues from Central devolution, yet SDLs averaged about 35% of revenues
- Rising borrowings alongside rising devolution signal structural stress rather than temporary imbalance
Macroeconomic and Federal Concerns
- Debt is increasingly replacing devolution as the primary fiscal shock absorber
- Rising debt-to-GSDP ratios threaten long-term fiscal sustainability
- Borrowing to fund revenue expenditure crowds out public capital expenditure and private investment
Way Forward
- Increase effective tax devolution to States
- Rework horizontal devolution criteria to better reward tax effort and efficiency
- Bring cesses and surcharges into the divisible pool to restore fiscal balance and State autonomy
Sample UPSC Mains Question
Central tax devolution is increasingly being replaced by State borrowing as the primary shock absorber in India’s fiscal federal system. Examine the causes and implications of this shift, and suggest measures to restore fiscal federal balance.