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Can Poor States Afford the Fiscal Responsibility Legislation?

An analysis of revenue and expenditure trends in the six least developed states for the period 2003-04 to 2007-08 reveals how these states have met the Twelfth Finance Commission revenue deficit targets ahead of the 2008-09 deadline. In their rush to meet these targets, the states may have cut down expenditure in the very sectors where progress is most crucial to lift them out of their present least developed status.






Can Poor States Afford the Fiscal Responsibility Legislation?

Tanya Sethi




this had on the expenditure on important social services?

1 Introduction

The Fiscal Responsibility and Budget Management Act (FRBMA) at the centre was notified in 2004. At the state level, the

An analysis of revenue and expenditure trends in the six least developed states for the period 2003-04 to 2007-08 reveals how these states have met the Twelfth Finance Commission revenue deficit targets ahead of the 2008-09 deadline. In their rush to meet these targets, the states may have cut down expenditure in the very sectors where progress is most crucial to lift them out of their present least developed status.


concern with the fiscal and reve nue deficits has always dominated discussions on government finances in the mainstream media. For instance, after the presentation of the union budget for 2009-10, there was much speculation and criticism that the combined fiscal deficit at the centre and the states would touch 12% of the gross domestic product (GDP) in 2009-10. However, it is selfevident but not always acknowledged that the case for fiscal sustainability should not rest purely on numbers, but rather on the composition of expenditure by the government.

This article examines the trends in the revenue and expenditure of the poorest of the states in recent years. This examination is done in the context of state governments meeting fiscal and revenue deficit targets as recommended by the Twelfth Finance Commission (TFC).

Two questions dominate the analysis:

(1) How have these states met the targets

– through revenue expansion or expenditure compression? (2) What impact has

october 10, 2009

TFC, whose recommendations covered the period 2005-10, recommended that each state enact the fiscal responsibility legislation (FRL). States’ eligibility for a debt waiver was contingent on enactment of the FRL. They were expected to eliminate their revenue deficits by 2008-09, and bring down the fiscal deficit to 3% of the gross state domestic product (GSDP) in a phased manner by 2009-10.

The timeline of enactment of the legislation has not been uniform across the states, with five states doing so in 2003-04 and some others later, in 2006-07. The deficit indicators reveal that while the centre has not been able to meet these targets, the states, at the consolidated level, achieved a revenue surplus of 0.6% of GDP and a gross fiscal deficit (GFD) of 1.9% of GDP as early as 2006-07 (RBI 2008). In fact, these indicators further improved to 0.9% and 1.5%, respectively for the year 2007-08 (RBI 2009). During 2008-09, 25 states budgeted a revenue surplus and 17 states budgeted a GFD at less than 3% of GSDP1 (RBI 2008). This has been attributed to the incentive scheme as per the TFC’s recommendation, revenue buoyancy

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of the centre and introduction of the statelevel value-added tax (VAT). The Economic Survey (2008-09) also points out that the latter has led to improved performance in terms of states’ own tax effort collectively, during the period 2005-06 to 2007-08; and non-tax revenue has also risen sizeably. Simultaneously, there has been a reduction in expenditure as a proportion of GDP in both revenue and capital accounts. The Reserve Bank of India (RBI) report on state finances for 2008-09 has made a similar observation:

Within the framework of the FRLs, there are budgetary constraints on substantially raising public expenditure that is financed by deficit or borrowings. This necessitated the adoption of a revenue-led strategy with measures of expenditure rationalisation to gain fiscal space in undertaking social and other development expenditures by the state governments.

Table 1: Key Deficit Indicators (as % of GSDP)

This is done with a view to understand how these states have managed to meet their TFC targets ahead of the deadline of 2008-09 despite being the poorest states in the union. An attempt is made to locate the sources in revenue and expenditure, which may have led to the successful attainment of these targets.

2 Deficit Indicators

Table 1 presents the revenue deficit (RD) and fiscal deficit (FD) figures for the six least developed states for the five-year period 2003-04 to 2007-08. The data are of the revised estimates of the two individual deficits as a proportion of the GSDP. The trends are not uniform but one aspect stands out: five of the six states had met the TFC’s revenue deficit target by 2007-08 and

3 Revenue Performance

The manner in which deficits can be reduced are by stepping up revenues, cutting down expenditures or a combination of both. This section looks at the composition of revenue receipts of the identified states from 2003-04 to 2007-08. The most important tax reform at the state level during this period has been the introduction of the state VAT, though this has not been uniform across the states. In addition to this, the TFC recommended an increase in the states’ share in central taxes and also raised the indicative limit of overall transfers out of the gross revenue receipts of the centre.

Table 2 looks at own tax revenue (OTR), own non-tax revenue (ONTR), and current transfers (CT) as a percentage of GSDP for the six states. OTR comprises taxes on income, taxes on property and capital trans

Bihar Madhya Pradesh Rajasthan Uttar Pradesh Orissa Jharkhand

actions, and taxes on commodities and


services. The ONTR component includes

2003-04 1.9 7.2 6.2 10 3.9 8.5 9.7 9.9 6.2 11.5 -0.4 4.8

interest receipts, dividends and profits,

2004-05 0.5 5.6 -1.4 6.3 2.4 6.5 2.9 5.6 3.8 5.6 2.5 8.1 2005-06 0.3 8.3 0 4.4 0.7 5 1.2 5.1 0.8 2.2 3.2 10.2 general services, social services, fiscal

2006-07 1.1 10.4 -1.4 3.7 -0.1 3.6 -1.1 3.6 -1 1.3 2 9.8 services and economic services. The share

2007-08 -3.6 3.4 -2.4 3.2 -0.1 3.3 -2.6 3 -1.6 1.1 1.9 8 in central taxes and grants from the cen-Actuals for all these indicators as a proportion of GSDP are not available, hence we have used revised estimates (RE).

tre together constitute CT to the states.

Negative sign indicates surplus in deficit indicators. Source: State Finances: A Study of Budgets, RBI, various issues. There is no secular pattern in the OTR over

This article focuses on the six non-special had either met, or were very close to meet-the five-year-period; there are changes from category states, which have the lowest per ing the target for the GFD as well. year to year, though the states as a whole, capita incomes (at current prices) as per Among the 17 non-special category with one exception, seem to share these the ranking by the Planning Commission states, Bihar achieved the highest revenue year-to-year changes. Except Jharkhand, in 2008.2 These six non-special category surplus – 3.6% of GSDP. Uttar Pradesh (UP) all the states show a fall in the OTR as a perstates which have been thus identified was the first among the six states to enact centage of GSDP from 2003-04 to 2004-05, include the four “BIMARU” states (Bihar, the FRL, and the last to introduce VAT. and then an increase in the next two years. Table 2: Revenue Indicators (as %of GSDP)

Bihar Madhya Pradesh Rajasthan Uttar Pradesh Orissa Jharkhand Year OTR ONTR CT Total OTR ONTR CT Total OTR ONTR CT Total OTR ONTR CT Total OTR ONTR CT Total OTR ONTR CT Total

2003-04 5.9 0.8 17.1 23.8 7.8 1.8 7.8 17.4 8.2 2 6.6 16.8 6.6 0.9 8.4 15.9 6.6 1.9 11.7 20.2 6.6 3.4 11.7 21.7

2004-05 5.5 0.5 20.7 26.7 7.3 4.1 7.5 18.9 7.7 1.9 6.5 16.1 6.4 0.9 8.4 15.7 6.2 1.8 11.9 19.9 5.3 2.7 8.2 16.2

2005-06 6.5 0.5 24.6 31.6 8.2 2.1 9.3 19.6 8 2.1 6.9 17 7.7 0.9 9.6 18.2 7.3 2.1 13 22.4 6 2.9 8.2 17.1

2006-07 6.8 0.5 27.1 34.4 8.3 1.9 10.1 20.3 8.1 2.3 7.8 18.2 8 1.8 9.9 19.7 8 2.6 14 24.6 5.8 2.7 10.4 18.9

2007-08 4.7 0.4 22.3 27.4 8.4 1.8 10.8 21 7.7 2.3 8.1 18.1 8 2 12.1 22.1 6.6 1.9 12.3 20.8 4.6 2.1 8.4 15.1

Actuals for all these indicators as a proportion of GSDP are not available, hence we have used revised estimates (RE) Source: Same as Table 1.

Madhya Pradesh, Rajasthan, Uttar Pradesh), However, it managed to meet the TFC tar-For 2007-08, except for MP, which had a as also Orissa and Jharkhand. gets by 2007-08 with a RD of -2.6% of marginal increase, all the others showed a

The analysis is based on data up to GSDP and a GFD of 3%. Madhya Pradesh drop in OTR/GSDP. Table 2 shows that while 2007-08 (actuals), and where actual figures (MP) achieved a surplus in the revenue there is no particular trend in the ONTR/ were not available, revised estimates (RE) account as early as 2004-05 and this con-GSDP ratio that is characteristic of the six have been used.3 While the states have tinued up to 2007-08.

Table 3 : Share of Current Transfers in Total Revenue Receipts (CT/TRR)

* indicates RE; all figures for Jharkhand are RE

presented their budgets for 2009-10, the Jharkhand was the only Year Bihar MP Rajasthan UP Orissa Jharkhand
RBI’s comprehensive annual report on exception, and that state 2003-04 (Actual) 71.85* 42.13 39.58 49.8 53.43 53.94
state finances is yet to be published for too was, from 2004-05, 2004-05 (Actual) 76.07 38.03 40.64 51.1 53.4 50.35
2009-10. moving in the direction of 2005-06 (Actual) 77.1 45.02 39.45 52 53.61 47.83
The analysis is of trends in the revenue a secular decline in the 2006-07 (Actual) 80.31 48.89 41.24 51.3 52.01 55.03
and expenditure over the period 2003-04 to RD, while this was not so 2007-08 (RE) 81.46 51.58 44.6 55 59.27 55.65

2007-08. for the GFD. Source: Same as Table 1.

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Table 4 : Expenditure Indicators (as %of GSDP) represents dependence on external funding,
Year DE Bihar SSE Madhya Pradesh DE SSE RajasthanDE SSE Uttar Pradesh DE SSE Orissa DE SSE Jharkhand DE SSE the share in central taxes, in part, is sourced
2003-04 17.8 12.4 18 8.4 16.2 10.4 21.2 7.5 18.5 10.8 17.8 12.6 from the own revenue of the states.
2004-05 18.7 12.8 17.6 7.4 14.6 9.3 11.7 7.4 12.6 8.9 17.7 11.4 Aggregating across the three revenue
2005-06 24.4 15.7 18 8.8 14.6 9.3 13.7 8.4 13.4 9.5 20.2 12.8 sources, the consolidated pattern reveals that
2006-07 29.2 18.7 15.7 9.3 14.4 9.3 14.3 8.4 14.4 9.4 22.1 13.8 except Jharkhand, all the states experi
2007-08 20.7 13.2 16.3 9.4 15.2 9.3 16.5 9.2 13.1 8.2 16.6 10.3 enced a steady increase in their revenues

Actuals for all these indicators as a proportion of GSDP are not available, hence we have used RE. DE-Development expenditure includes development components of revenue expenditure, capital outlay and loans and advances by the state governments. SSE-Social sector expenditure includes expenditure on social services, rural development and food storage and warehousing under revenue expenditure, capital outlay and loans and advances by the state governments.

Source: Same as Table 1.

states, from 2006-07 to 2007-08, all of them show either stagnation or a decline in this component (UP shows a marginal increase).

Thus, one can say that in general, there has been a drop in the own revenue component of the GSDP for these states in 2007-08.

As per the RBI’s report on state finances for 2008-09, OTR and ONTR make up 60% of the states’ revenues; the remaining 40% being met from devolution and transfers by the central government.

In order to understand the importance of transfers in the finances of these states, we look at the share of current transfers in the total revenue receipts (TRR) as presented in Table 3 (p 19). It is seen that for Bihar, CT constituted 71.8% of its total revenue receipts in 2003-04 and this share has been increasing till 2007-08 (RE). UP and MP show a similar trend though CT/TRR was at a lower level than that of Bihar (at around 50%). Among the BIMARU states, except for Bihar, all states show a rise in their CT/GSDP over the five-year period. This is in contrast to the trend shown by the OTR and ONTR, especially for 2007-08. Orissa and Jharkhand show a rising trend till 2006-07 followed by a drop in 2007-08. Thus, three of the six states (MP, Rajasthan and UP) saw an increasing CT/GSDP from 2004-05 to 2007-08. It should be noted that while the grant component of CT fully over the five-year period; and in Bihar and Orissa, there is a drop only for 2007-08.

4 Expenditure Pattern

As mentioned earlier, the RBI report on state finances for 2008-09 points to the fact that the fiscal consolidation under the FRL framework in the recent period has been brought about by an increase in revenue receipts and a curtailment of revenue expenditure.

We now look at some major heads, which fall largely under the purview of state governments. Table 4 examines trends in expenditure patterns in the six states in the specific areas of social and economic infrastructure.

These are under two broad heads of development expenditure (DE), and social sector expenditure (SSE) taken as a

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Workshop Outline

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Faculty Lance Strate is the Executive Director of the Institute of General Semantics, USA and Professor in the Department of Communication and Media Studies, Fordham University, New York. He is the author of Echoes and Reflections: On Media Ecology as a Field of Study (2006), and is completing another book to be titled Understanding Media Ecology. He has edited several anthologies of criticism on media and communication studies, including The Legacy of McLuhan (2005), Communication and Cyberspace: Social Interaction in an Electronic Environment (2003), and Critical Studies in Media Commercialism (2000). He has also edited General Semantics Bulletin (2007-08), and Explorations in Media Ecology, a quarterly journal, published by the Media Ecology Association, USA.

Registration Fee Each participant is required to pay a registration fee of Rs. 800/ (Rupees Eight hundred only) through a bank draft in the name of Balvant Parekh Centre for General Semantics and Other Human Sciences on any Bank in Baroda. The fee will take care of the cost of reading material, lunch and tea during the workshop. The participants have to make their own travel arrangements. The Centre will try to arrange their accommodation at the Guest House of the M. S. University of Baroda on request. Deadline for sending the registration fee is: October 20, 2009.

october 10, 2009 vol xliv no 41

Economic & Political Weekly


Table 5 : Expenditure* on Education** and Health (as ratio of aggregate disbursements) set through the FRL are primarily responsi

Bihar Madhya Pradesh Rajasthan Uttar Pradesh Orissa Jharkhand

ble for the cash surpluses witnessed even

Year Education Health Education Health Education Health Education Health Education Health Education Health

in BIMARU states. The authors concluded

2003-04 (Actual) 18.9 3.8 9.9 3.3 14.1 4 9.1 2.7 12.2 3.2 14.2 4.1

that a reduction in the revenue deficit has

2004-05 (Actual) 15.8 3.1 8.8 3.1 13.8 3.7 12.5 3.8 12.6 4 14.9 3.7

been achieved by not spending the in

2005-06 (Actual) 19.6 4.5 10.2 3.4 17.2 4.4 15.2 5.1 14.7 3 15.8 6.9

2006-07 (Actual) 19.7 4.2 12.4 3.8 15.6 4.1 14.7 5.7 12.8 3.1 15.2 6.3 creased revenue and capital receipts. In

2007-08 (RE) 16.7 3.9 11.6 3.7 14.5 4.1 14.1 5.2 13.5 3.5 15.1 5 fact, the rising cash reserves have often

* includes revenue expenditure and capital outlay. ** also includes expenditure on sports, art and culture.

Source: Same as Table 1.

percentage of the GSDP. Development expenditure in Table 4 includes expenditure on social and economic services; SSE includes expenditure on social services and two components of economic services – rural development and food storage and warehousing. Both are a hybrid of elements of revenue and capital outlays, and also include loans and advances by state governments. There is no particular trend common to all the states; in fact, one sees yearly fluctuations in DE and SSE even within the states. However, what emerges strongly from the data in Table 4 is that for five out of the six states, the DE in 2007-08 is lower than what it was in 2003-04.

Expenditure in two crucial areas, education4 and health5, as a ratio of aggregate disbursements, is shown in Table 5. All the states spend about 3-5% of their total expenditure on health. The expenditure on education shows a wider interstate disparity, with Bihar spending close to 19% of total disbursements in this area and MP only 11%. The average for the other states is 13-15%.

As with the data on development and social sector spending, expenditure on education and health also shows different trends in individual states. Bihar stands out among the rest in that it sees a sharp drop in DE and SSE in 2007-08 by almost 30%, after showing a rising trend from 2003-04. However, even in the years of increasing DE and SSE, education and health expenditures seem to tell a different story, marked by yearly variations. Rajasthan is the only state among the BIMARU states which has not seen any increase in both DE/GSDP and SSE/GSDP, which have remained constant at 14.6% and 9.3%, respectively since 2004-05.

In general, what emerges is that irrespective of interstate variations, for four out of six states, education and health expenditures saw a dip in 2006-07 and 2007-08. The larger point is that even as states were reducing their revenue and fiscal

Economic & Political Weekly

october 10, 2009

deficits between 2003-04 and 2007-08, they were simultaneously holding down their development expenditure, including in the important areas of health and education, two sectors where outlays have always been less than adequate.

Divergent Trends

While the interstate differences in trends do not allow us to make sweeping conclusions, a few points that emerge from this analysis are worth taking note of.

Since we are particularly interested in the years that these states attained a revenue surplus, we look at the indicators for the year 2007-08. Three of the six states (MP, Rajasthan and UP) which had an increase in CT/GSDP also show an increase in DE and SSE as a proportion of GSDP in the year 2007-08. These are also the states that have had relatively stable OTR and ONTR as a proportion of their GSDP as compared to the other states which saw a drop in revenues. However, when we look at the expenditure on education and health, all these states show a uniform drop for the year 2007-08.

In fact, what is common to all the six least developed states is the falling share of education and health spending in their total expenditure, which is seen most clearly in 2007-08. Moreover, the increasing trend in aggregate revenues does not get reflected in their development expenditure over the five-year period. What is noteworthy in this context is that these are the only states which have been recommended by the TFC to receive grants for the education and health sectors from 2005-06 up to 2009-10.6 (Rajasthan does not receive a grant for health). These grants are additional, over and above the normal expenditure that these states incur on these sectors.


In a paper published earlier in this journal by Isaac and Ramakumar (2006), it was argued that limits to expenditure increases

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been cited as the reason for the centre passing on the responsibility of increasing social sector expenditure to the states. This article explores the claim in the case of six states ranked lowest according to per capita incomes.

While expenditure for development purposes has seen an improvement in recent years, it is still lower than the levels achieved in the early 1990s (RBI 2008). Expenditure on social services, which includes in large part education and medical and public health expenditure, is largely treated as revenue spending in the budget accounts, irrespective of whether it leads to asset creation or not. While this reflects the larger problem of ambiguity in defining such expenditures, what is important here is that social sector spending is regarded as “compressible”, since nondevelopment expenditure mostly comprises “committed” outlay. This view can prove to be detrimental to the interest of the poor states, as is illustrated by the data, and lead to a situation where these states remain trapped in the low-income group. There is therefore a need to assess the impact of the TFC-recommended target, not just on revenue receipts and expenditures, but also on the overall development levels of the states. In the pressure to meet the time bound targets, these states have been compelled to neglect the very sectors that can pull them out of their present status of being the “least-developed states”.


1 The RBI Annual Report (2008-09) states that in 2009-10, the consolidated revenue account of state governments is budgeted to turn into deficit of 0.6% of GDP and only 13 states have budgeted a revenue surplus, as against 23 states during 2008-09 (RE). While this is understandable in the present context of the global turmoil, the report also notes that revenue expenditure is budgeted to increase during 2009-10 over 2008-09 (RE) mainly due to increase in non-development expenditure. Higher expenditure on administrative services, on account of the Sixth Pay Commission recommendations, pension and interest payments together would contribute around 63% of the increase in revenue expenditure in 2009-10. Gross fiscal deficit is also likely to worsen from 2.7% in 2008-09 (RE) to 3.4% in 2009-10 (BE). In the union


budget 2009-10, the GFD limit for the states has these have not been included in the analysis (giv
been increased to 4% of GSDP. en that there is almost always some discrepancy
2 This ranking is for 20 states and excludes small between BE and RE/actuals).
states and union territories. Though the latest ranking of states based on per capita incomes is 4 Expenditure includes outlay on education, sports, art and culture
available for the year 2005-06, in this article we 5 Includes expenditure on medical and public
take the ranking for 2004-05 for identifying the health, and family welfare.
poorest states. This is because due to some inexpli 6 Grants for the education and health sectors are an
cable reason Jammu and Kashmir jumped to the second position in 2005-06, after being in position eight for two consecutive years 2003-04 and 2004-05 additionality, over and above the normal expenditure to be incurred by the states in these sectors. See “Main Recommendations of the Twelfth Finance
(in the ascending order of per capita incomes). Commission”, available on
3 Though the budgeted estimates (BE) of 2008-09 are available, in order to maintain consistency, the_ministry/dept_expenditure/plan_finance/FCD/ main-recomm.html accessed on 2 September 2009.


GoI (2009): Economic Survey (2009-10), Ministry of Finance, Government of India.

Isaac, Thomas and R Ramakumar (2006): “Why Do the States Not Spend?”, Economic & Political Weekly, Vol 41, No 48.

Planning Commission (2008): “Ranking of States Per Capita Income Wise-Current Prices”, available on of States Current.pdf accessed on 17 August-September 2009.

RBI (various years): State Finances: A Study of Budgets, Reserve Bank of India.

– (2009): Reserve Bank of India Annual Report 2008-09.





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