The fiscal circumstances of India’s States have attracted significant attention recently, but much of the analysis has focused on larger States. There is a pressing need for more discussion surrounding the fiscal health of smaller States—defined as those with populations under 1 crore. Many of these smaller States exhibit unique characteristics that hinder their ability to generate revenue. To address these limitations, the Constitution has established mechanisms aimed at supporting them. Nevertheless, these States remain heavily reliant on the Union government for revenue, which creates vulnerabilities for both the States and the Union.
State revenue receipts comprise various components, including transfers from the Union government (such as shares in income tax and corporation tax, along with grants) and the States’ own revenues, generated from both tax (own tax revenue or OTR) and non-tax sources (own non-tax revenue or ONTR).
Revenue receipts for each of the small States have seen an increase, with six out of nine experiencing growth rates faster than their gross state domestic product (GSDP). However, these increases largely result from Union transfers rather than from the States’ own revenue sources. For instance, in three States—Mizoram, Sikkim, and Tripura—the growth in revenue receipts has lagged behind their GSDP, indicating limited fiscal space for effective governance.
Currently, the share of Union transfers within the revenue receipts of all States ranges from 40% to 50%, but this ratio is significantly higher among smaller States. In all small States except Goa, over 60% of revenue receipts derive from the Union government, with five of these States reporting Union’s share at around 90% according to the 2022-23 Budget Estimates.
While the economies of these States have expanded, this growth has not translated into enhanced revenue-raising capabilities, as evidenced by the sustained dominance of current transfers in their revenue receipts from 2014 to 2023. Small States typically have limited capacity to levy their own taxes, with eight out of nine faring worse than the all-State average OTR-GSDP ratio.
Despite a relatively stronger performance in ONTR mobilization compared to OTR, with six States exceeding the all-State average, others like Manipur, Tripura, and Nagaland consistently underperform in their ONTR-GSDP ratios. This persistent inability to mobilize revenue underlines the significant reliance of smaller States on Union government support, which exposes them to various risks.
Among these risks, States’ dependence on Union transfers hinges on political goodwill; any sudden decline in funding could adversely affect their expenditures. Recent disputes over resource sharing—such as conflicts over GST compensation—have highlighted this vulnerability. Furthermore, high reliance on Union funds could constrain States’ fiscal autonomy since a considerable portion of these transfers is earmarked for specific purposes. This situation may diminish States’ abilities to deliver essential social and economic services, an issue compounded by the fact that many small States share borders with other countries, raising national security concerns.
To address these vulnerabilities, small States must explore new avenues for tax revenue or find ways to optimize existing sources. A study by Manipur University examined how liquor prohibition policies have resulted in substantial revenue losses for the state without significantly mitigating the issues associated with alcohol consumption. Additionally, a financial assessment of Arunachal Pradesh identified opportunities to generate more funds through land transactions and sales taxes.
Improving tax administration can significantly enhance resource mobilization and reduce discrepancies between projected and actual tax revenues. States can also increase non-tax revenues by revising fees and improving the efficiency of revenue collection. Furthermore, many state-owned enterprises in these regions are underperforming, which prompts a need for revitalization and corporatization to bolster revenue collection. Some States, such as Mizoram, have already taken steps to close down loss-making public sector enterprises, recognizing them as financial liabilities.
Sarthak Pradhan is an Assistant Professor at the Takshashila Institution, and this research was supported by The International Centre Goa Research Grants.
Source: “State Finances: A Study of Budgets,” Reserve Bank of India.
