B Sivaraman

Fiscal federalism, a casualty of the Modi Era | Budget and the states


Fiscal federalism, a casualty of the Modi Era | Budget and the states
x
A skewed distribution of federal resources is because of a controversial formula for devolution based on population and incidence of poverty. Image: iStock

Socio-political considerations shouldn't govern fiscal federalism; and, Hindi belt states aren't effectively using their Central funds largesse for rapid growth

Narendra Modi used to make a strong case for more resources to states when he was the Chief Minister of Gujarat. When he assumed office as the Prime Minister in 2014, he proclaimed cooperative federalism as his government’s watchword. Did this remain a jumla (mere statement/act) or does the fiscal record of his government show it has some substance?

This is the 12th budget of the Modi regime. We shall examine to what extent the latest budget — as well as the 11 earlier ones — adhere to the principles of federal justice.

Skewed distribution

Union Budget 2025-26 has devolved Rs 14,22,444.11 crore out of the total tax revenue of Rs 28,37,408.89 crore (Budget Estimates, or BE), which is nearly 50 per cent, to the states.

The Centre has allocated Rs 2,55,172.43 crore to Uttar Pradesh, Rs 1,43,069.43 crore to Bihar, and Rs 1,11,661.87 crore to Madhya Pradesh. But it has allocated only Rs 58,021.50 crore to Tamil Nadu, Rs 27,382.06 crore to Kerala and Rs 51,876.54 crore to Karnataka. The allocation to Maharashtra is Rs 89,855.80 crore and Gujarat, Rs 49,472.62 crore.

In other words, Uttar Pradesh gets more than Tamil Nadu, Kerala and Karnataka combined. Bihar gets more than what Maharashtra and Gujarat together receive. Why such discrimination? The Centre passes the buck to the Finance Commission.

Also read: Siddaramaiah attacks Centre on 'unfair devolution of taxes'; invites 8 CMs for conclave

The 15th Finance Commission had recommended devolution of 41 per cent of the total tax revenue as the share of the states. When states like Tamil Nadu, Kerala and Karnataka raised objections over discrimination meted out to them, the Union Finance Minister countered them, citing data to say her budgets faithfully stuck to the Finance Commission formula. They even surpassed the 41 per cent mark some times, she said.

See below the year-wise share. Instead of calculating states’ share in the gross tax revenue of the Centre, we have collated the figures for the total tax revenue, which is gross tax revenue minus refunds.

Finance Commission recommendations

In fact, the 14th Finance Commission had recommended the devolution of 42 per cent of the total tax revenue to the states, while the 15th Finance Commission slashed it to 41 per cent, effective 2020. Collectively, the states should have been deprived of around Rs 35,000 crore due to this decision since then.

At first sight, it might look as if the Union government is sticking to the Finance Commission formula and has even surpassed it marginally a couple of years. But the real discrimination is not in the aggregate count.

If we examine the state-wise breakup, the discrimination suffered by some states is clearly visible.

Click here to read the numbers in detail.

Controversial formula

A quick look at the chart above brings out the discrimination among states. Usually, it is the backward states which would be discriminated against. But, in this instance of discrimination turned inside-out, it is the developed states of the South and West that get a raw deal.

Invariably, year after year, a state like Uttar Pradesh alone gets more funds than Tamil Nadu, Kerala and Karnataka put together. Bihar usually gets more than what Maharashtra and Gujarat get.

Also read: Stalin meets 16th Finance Commission, seeks steps to boost federal structure

This skewed distribution of federal resources is because of a controversial formula for devolution based on population and incidence of poverty. A state that eliminates poverty faster would get fiscally punished due to this “poverty premium”. A state that controls population more effectively would pay the penalty for greater development.

Despite this discriminatory pandering to the Hindi belt states, probably because they send the largest number of MPs to Parliament, these states would take at least two or three decades to catch up with the present stage reached by the West or South in economic, human development and vital indicators.

Effective use of funds

Socio-political considerations should not govern fiscal federalism. Some would argue that if more money is devolved to relatively advanced regions, high-paid quality jobs would be created, consumption would get a boost, productivity would go up and these regions which are already providing employment to millions of migrants from UP-Bihar-Jharkhand — can have a greater spillover effect on these backward regions.

Under the given political reality, the Hindi belt states are not effectively using the federal funds for rapid transformation.

Nitish Kumar has completed 10 years in office in Bihar in alliance with the BJP. Just recall the hype about his ending the 'jungle raj' in Bihar and making it the Gujarat of the East. After 10 years, if you draw the balance-sheet, Bihar still remains industrially barren.

Biased federalism

Next to devolution of taxes, grants by the Centre, which are discretionary, constitute the second major component of devolution from the Union government. Grants to states rose from ₹1,45,557 crore in 2010 to ₹9,69,391 crore in 2025. Last year, nine states received non-plan grants amounting to ₹9,528.14 crore.

Bihar was sanctioned grants amounting to ₹9,999 crore over a five-year period (2021-22 to 2025-26). A special allocation of ₹335 crore was made under the Pradhan Mantri Uchchatar Shiksha Abhiyan for four universities and 15 colleges.

Madhya Pradesh got ₹1.2 lakh-crore for urban local bodies and ₹2.4 lakh-crore for rural local bodies. In contrast, Tamil Nadu received ₹10,500 crore for the Public Distribution System and ₹3,100 crore for loan-waiver schemes in the context of torrential rains.

In the 2025-26 Budget, the Demand for Grants of the Ministry of Health reveals that no specific allocation has been made this year for the proposed AIIMS in Madurai. The Budget has earmarked ₹1.5 lakh-crore for non-tax discretionary grants by the Centre to the states. But most of these grants are for road projects in Uttar Pradesh and Maharashtra, where the BJP just returned to power.

Also read: Tax allocation reignites fiscal federalism war; Karnataka may resume stir

Pending projects

Other than grants, the Receipt Budget also lists 483 pending projects all over India where the annual installment is due. The total unpaid annuity liability of the Centre till the end of the financial year 2023-24 stands at Rs 2,80,097 crore.

The Modi government excels in making flashy announcements of projects, and Modi personally launches all grand inaugurations, big or small, especially on the eve of elections, and forgets to shell out money once the polls are over.

Also read | States’ fiscal deficits swell as welfare spending trumps financial prudence

Thanks to the wave of competitive populism by states, their capital expenditure is witnessing a steady decline. The decline in 2020-21 was mainly due to COVID, but the downward trend continued later, too.

In April-November 2024, the aggregate capital investment by the states witnessed a 7 per cent fall. This doesn’t augur well for the future development of the states. Many economists have sounded out a note of warning.

Federal injustice

Persistent federal injustice has evoked strong protests from the Opposition-ruled state governments. The year 2024 witnessed the bizarre spectacle of southern chief ministers trooping to Delhi to sit on hunger strikes.

For the sake of federal posturing, the Modi government did come up with a 'Scheme for Special Assistance to States for Capital Expenditure' in 2020. In 2023, it was rechristened as the 'Scheme for Special Assistance to States for Capital Investment' and its corpus was expanded to Rs 1.5 lakh-crore.

Under this scheme, the states can get 50-year interest-free loans for capital investment. Uttarakhand and Kerala suffered huge landslides but they could get only 2 per cent of the paltry funds earmarked for this scheme for rebuilding their roads and bridges.

Until 2024 end, only Rs 1.67 lakh-crore had been allocated under this scheme. In 2024, the bulk of the special assistance (loan) allocated by the Centre under this scheme has been garnered by Uttar Pradesh, for which development means highway building and organising or holding mela spectacles.

Despite grabbing the lion’s share of central funds under this scheme, the Yogi Adityanath government, which keeps unabashedly flaunting its religious identity for political gains, has not been able to build some permanent infrastructure for even religious tourism. In 2024, under this scheme, UP got Rs 12,458.43 crore, Bihar Rs 6,135.54 crore, Tamil Nadu received Rs 2,643.65 crore and Kerala did not get any money. There is no increase for this scheme in the 2025-26 budget.

Also read | Andhra vs Telangana: Flood relief raises stink of Centre’s ‘partiality’

Neglect of social sectors

If there is no due attention to the social sectors in the Union Budget, it is the states which would ultimately suffer. A teacher in Allahabad University told The Federal that due to a funds crunch, only temporary teachers are being appointed in all central universities and the quality of education suffers.

“The Modi government only wants to curry favour with the upper middle class by increasing the number of IIT seats. They engage in tokenism in controlling the prices of medicine but the government does nothing to control the fees in private educational institutions and private hospitals. Around Rs 500 crore to set up a Centre of Excellence for Artificial Intelligence in education would also not address the real crisis of educational standard in schools, especially in UP. Can the 50,000 Atal Tinkering Labs proposed to be set up in schools even tinker with 14.72 lakh primary schools in India?”

Also read: States’ fiscal deficits swell as welfare spending trumps financial prudence

Echoing similar views, Dr Joseph Amalorpavanathan, member, Tamil Nadu Planning Commission, told The Federal: “Instead of controlling the prices of select medicines, the Finance Minister should have regulated the price of all medicines so that the mass of the poor would be benefited. Increasing medical seats by 75,000 would be of no use to the poor unless the public health infrastructure is beefed up and more doctors are appointed.”

The total allocation for the Health Ministry is Rs 95,957.87 crore for 2025-26 and this constitutes a meagre 0.224 per cent of the GDP of Rs 319.55 lakh-crore. The government should have allocated 2.5 per cent of the GDP to the health sector as recommended even by the 15th Finance Commission.

Also read | ‘Politics’ over PM-JAY: Stats show non-BJP states used scheme better

This year the allocation for MGNREGA has been nominally increased to Rs 95,000 crore from Rs 86,000 crore in 2024-25. But in real terms this nominal increase would amount to nothing as by December 2024 the Centre owed Rs 11,424 crore to the state as dues.

In sum, Nirmala’s eighth budget has done pretty little to promote more equitable fiscal federalism. A dozen budgets from the Modi government and federal justice in India goes for a toss.

(The Federal seeks to present views and opinions from all sides of the spectrum. The information, ideas or opinions in the article are of the author and do not necessarily reflect the views of The Federal.)

Next Story