State finances: budgets, borrowing and dependence on transfers

State governments provide most everyday public services in India, including police, health, school education, water supply and agriculture extension, but they raise a smaller share of total tax revenue than the Union. States rely on their own taxes, such as state GST, excise on alcohol, stamp duty and vehicle taxes, on non-tax revenue, and on transfers from the Union, including tax devolution recommended by the Finance Commission and grants for schemes. This vertical imbalance, where spending responsibilities exceed revenue powers, is a defining feature of Indian fiscal federalism.

The Finance Commission, a constitutional body under Article 280, recommends how the divisible pool of central taxes is shared between the Union and states, and among states, using criteria such as income distance, population, area and performance. For 2021-22 to 2025-26, the Fifteenth Finance Commission recommended that states receive 41 per cent of the divisible pool, down from 42 per cent under the Fourteenth Commission, with the change linked to the creation of new union territories. Grants for local bodies, disaster management and sector-specific purposes supplement devolution, while centrally sponsored schemes fund national priorities through state implementation, sometimes with matching state contributions.

States also borrow, mainly through market loans and small savings, within limits set under Article 293, which requires Union consent if a state owes money to the Centre. State fiscal responsibility laws set deficit and debt targets, but states have at times used off-budget borrowings through public corporations to fund spending without showing it in their budgets, a practice the Union and the Reserve Bank have sought to bring within borrowing ceilings. High debt in some states, driven by salaries, pensions, subsidies and power-sector losses, limits their ability to invest, while richer states argue that devolution criteria penalise their performance and population control.

For civil studies, state finances show why federalism is fiscal before it is rhetorical. A state cannot deliver health or education without revenue, borrowing room and administrative capacity, and Union transfers that are tied to many conditions can reduce state autonomy. The balance between equity, giving poorer states more, and incentives, rewarding better performance, is the central normative choice in every Finance Commission award.