At the heart of this tension is the distinction between revenue and capital investment, a divide that is at the heart of the ongoing freebie debate. Revenue expenditures—spending on salaries, subsidies, and day-to-day administration—meet immediate needs and can yield short-term political dividends.
However, over-reliance on such spending risks increasing deficits without creating sustainable value. Freebies may provide temporary relief, but they often come at the expense of capital investments that drive growth.
This is why the case for prioritizing capital expenditures is compelling. Capital expenditures finance the creation of assets that not only increase productivity but also generate long-term fiscal dividends by widening the tax base. The synergies of capital investment are well documented. Every rupee spent can stimulate demand in all sectors, create jobs and attract private investment.
A 2013 study by Sukanya Bose and NR Bhanumurthy found that capital investment has the largest impact on economic growth, with a fiscal multiplier of 2.45, compared to 0.98 for transfer payments and 0.99 for other expenditures. .
Similarly, the Reserve Bank of India’s analysis for 2024 highlights that while the revenue expenditure multiplier averages 1.43 in the short term, the impact of capital expenditure is significantly larger, with a three-year peak multiplier of 3.84.
Ultimately, neither the overbearing “Leviathan” model nor the scaled-back “Lilliput” model will help India’s growth aspirations. As Thomas Sowell wryly reminds us, “The first lesson of economics is scarcity…The first lesson of politics is to ignore the first lesson of economics.”
Political promises and economic realities often collide, but states can use this conflict creatively if they direct revenue savings toward impactful capital projects rather than giveaways. The goal is not to cut essential welfare, but to align short-term obligations with long-term development strategies and help our infrastructure, education, and health systems thrive.
But how are states performing on this indicator? The RBI recently released the State Finance Report, which examines the fiscal reforms of each state. In 2023-24, states maintained a gross fiscal deficit (GFD) of 2.91 per cent of GDP, staying within the 3 per cent limit set by India’s Fiscal Responsibility Act, the report said.
States with the highest GFD in 2023-24 (revised estimates) (excluding northeastern states) are Bihar (8.9%), Chhattisgarh (7.3%) and Himachal Pradesh (6.1%). , Andhra Pradesh (4.4%) and Rajasthan (4.3%). %) and Punjab (4.1%).
Capital investment improved, rising from 2.2% to 2.6% of GDP in 2022-23. In 2024-2025, states aim to further improve the quality of spending while maintaining fiscal discipline with a budget GFD of 3.2% of GDP.
States have significantly changed their spending patterns, with revenue expenditures as a share of GDP falling to 13.5% in 2023-2024, approaching pre-pandemic levels. Development spending in areas such as health and agriculture has tapered off after the pandemic, while allocations for housing and social security have increased.
Capital investment rose to 2.8% of GDP in 2023-24 due to expanded tax devolution and interest-free loans from the Centre. States like Gujarat have demonstrated fiscal health by maintaining a balanced approach to revenue and capital expenditure.
The revenue expenditure to capital expenditure (RECO) ratio improved, falling from 6.3 in 2021-22 to 5.2 in 2024-25. Gujarat’s RECO ratio stands out at around 3.5, with a healthy balance in favor of growth-oriented capex. However, disparities still exist, with RECO ratios above 17 in states such as Punjab, reflecting unequal revenue expenditure. Maharashtra and Tamil Nadu improved.
However, regional disparities in spending patterns persist. States such as Bihar and Jharkhand continue to allocate a disproportionate share of their budgets to revenue expenditure.
States that are highly dependent on decentralization, such as Bihar, where 73% of resources are provided by the centre, often avoid spending reforms or raising their own revenues. Bihar maintains a prohibition law, resulting in lost tax revenue, reflecting a reluctance to optimize fiscal resources.
Competitive populism at the state level poses a threat to the sustainability of India’s fiscal framework. State governments, pressured by electoral politics, appear to be competing with each other in offering freebies and subsidies. This dynamic creates a structural impediment to fiscal health.
The federal government’s governance structure poses a classic collective action dilemma. In other words, each state operating under the principle of fiscal federalism externalizes the consequences of budgetary indiscipline to the center, a phenomenon that is based on Mancur Olson’s theory of “cost dispersion and concentration.” I can give an example. advantage. “
States often rely on the federal government (or more specifically, the Federal Fiscal Commission) to rationalize unsustainable spending patterns and deflect responsibility for reforms that reduce politically expedient but economically inefficient spending. They argue that the financial delegation from the government is insufficient. This is despite the fact that avenues for spending reform exist.
The author is a public policy expert.
