State Revenue – Loss In Times Of Lockdown

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With the imposition of nationwide lockdown and the resulting near-standstill in economic activity, the revenue sources of the government have taken a major hit. Both central and state governments are struggling with drying up of revenues, while simultaneously dealing with increased demand for expenditure in light of the COVID-19 crisis. However, the state governments are affected more as the bulk of expenditure takes place at the state level. Unlike the central government, many of the states depend on the central devolution of funds for its finances.

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What are the sources of state revenues?

  • The sources of state revenue can be classified under 2 heads:
  1. Own revenue sources– these include own non-tax revenues sources, SGST (State Goods & Service Tax), VAT (Value Added Tax) on petroleum products, state excise on alcohol, vehicle tax, stamps, registration fees and revenue from electricity (tax and duty).
  2. Devolution from the centre.
  • The 4 main sources of state revenue are:
  1. Own tax revenues
  2. Non-tax revenues
  3. State’s share in central taxes – as mandated by the Finance Commission
  4. Grants from the centre

How were the states’ finances before the lockdown?

  • The state finances were already affected before the incidence of the COVID-19 crisis and the imposition of the lockdown.
  • The states were already tackling a liquidity crisis which was expected to evolve into a fiscal crisis without the help of COVID-19 and the associated lockdown.
  • The country was already going through an economic slowdown accompanied by several pockets of crisis (banking sector, fiscal crisis, automobile sector crisis, etc.). This too was pressuring the state’s finances.
  • The dependency of the states on the centre increased with the advent of GST– as the centre is to compensate for revenue loss for 5 years (until 2022).
  • The state’s revenue scope from own revenue sources was higher during the pre-GST period. With the introduction of the GST regime, most of the indirect tax got subsumed.
  • There is also ongoing acrimony between the centre and states on the question of a new GST formula.
  • According to an RBI study, the own tax revenues of the states account for less than half of the total revenues of the states i.e., 45%. Of this, 90% is from taxes on alcohol, petroleum, stamp duty and vehicle registration.
  • Centre’s devolution to the states accounts for 5% of the states’ revenues.
  • The Q4 of FY20 faced a drop in central transfers (of nearly 14% compared to FY19). There has been a mismatch between the budget estimates (Rs.8.02 lakh crore) and the revised estimates (Rs.6.56 lakh crore) in the transfers to state in FY20.
  • It is expected that the central devolution to the states in FY21 will increase by 19.5% but this is dependent on the centre achieving its improbable aim of 12% total tax revenue growth.
  • Experts believe that the centre’s continuance in missing targets was a major contributor to the 1990s slippages.
  • The 15th Finance Commission’s recommendations (based on 2011 census) are expected to hit centre’s devolution to several states. Karnataka, Kerala, Telangana, Andhra Pradesh and Assam are expected to be the top losers.
  • Apart from this, there is the habitually low transfer of grants than promised by the centres to the states.
  • As a result, the states respond by delaying payments leading to piling up of bills in the treasuries. This is significant in light of the increase in complaints from the MSME sector about delayed payments from the government. The usual delay in payment of salaries to the many government workers in the state would also be further aggravated.
  • Another consequence is the cut in capital expenditure (Capex) as the revenue expenditure of the states can’t be postponed.
  • A significant portion of the centre’s devolution to the states was for the implementation of centrally-sponsored schemes. About 2% of the GDP is for such schemes. There has been a delay in even these devolutions.
  • Also, after the 14th Finance Commission recommendations, the fund sharing pattern for such schemes was altered so that the states pay more. This has had a snowballing effect on payment delays.
  • The recent corporate tax cut has added pressure on the state revenue sources.
  • The State Finance Commissions were made redundant with the Finance Commission allocating 3% of the divisible pool for local bodies.
  • With defence and security spending by the centre, the state revenues were facing pressure from both sides- top and bottom.

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What were the impacts of COVID-19 and the Lockdown on the state revenues?

  • The COVID-19 crisis was largely unexpected. It proved to be a shock to the country’s economy and consequently the government’s revenues.
  • According to India Ratings and Research, 21 major states recorded a collective loss of Rs.97,100 crore in own revenues in April alone.
  • States with a larger share of own revenue sources in the total revenue were the worst hit. These are progressive states like Telangana, Tamil Nadu, Kerala, Karnataka, Maharashtra, Goa, Gujarat and Haryana. This is because the State’s Own Tax Revenues (SOTR) has dropped by 80% to 90%.
  • Because of the lockdown, there haven’t been any vehicle and property registrations.
  • The sale of petroleum went down as the economic activity was at a near-standstill. The travel ban, leading to idle vehicles and aeroplanes, also contributed.
  • There has been a decline in revenue from the coal and mining sector due to reduced consumption. Up to Rs.12,000 crore is expected to be lost in revenues to the centre and key mining states.
  • On the other hand, there is an increasing demand for more spending – in terms of Direct Benefit Transfer to help the economically weaker sections and healthcare spending in terms of infrastructure, testing, quarantining and treating COVID-19 patients.
  • The Centre’s announcement that contributions to CM’s Relief Funds of States won’t qualify for CSR expenditure added to the woes.

How is the issue being handled?

  • States have resorted to austerity measures and are exploring new avenues for revenue sources.
  • The RBI increased the short-term borrowing limit of states under the Ways and Means Advances by 60% over and above the March 31st levels. This is expected to reduce the borrowing costs of the states. The new limit is to be applicable until the end of September.
  • States have increased their market borrowings. Top borrowers include Uttar Pradesh, Tamil Nadu and West Bengal.
  • The central government has increased the borrowing limit of the states from the previous 3% to the current 5% of their SGDP by relaxing the Fiscal Responsibility and Budget Management Act guidelines. This implies that the states can borrow up to 3.5% of SGDP freely.
  • The rest of the relaxation can be availed by the states conditionally i.e., if they adopt ‘One Nation, One Ration Card’ scheme, implement local urban bodies’ reforms, reform the discom sector and improve ease of doing business.
  • States have resorted to increasing the excise rates on liquor to meet the revenue deficits. Andhra Pradesh raised the liquor price by 75% while Karnataka increased it by 11%, Tamil Nadu by 15% and West Bengal by 30%. Delhi raised the price by 70% with the introduction of special coronavirus fees. Several other states like UP and Telangana also resorted to this tactic.
  • States have been increasing the VAT on petroleum products. At least 15 states have resorted to this measure, including Punjab, Tamil Nadu, Delhi, Uttar Pradesh, etc.

Why is there concern regarding these measures?

  • RBI has increased the WMA (Ways and Means Advances) limits but this is considered as inadequate by the states.
  • The increased market borrowings by the states can compensate only 50% of the collective revenue loss of the states.
  • Overall borrowing is expected to reach 12% of GDP.
  • The states are to borrow more than the Centre for the first time. If all states go for increased borrowings, the yields will increase by 10 to 15 bps.
  • Borrowing cost will rise with more state development loans entering the market.
  • 70% of the fuel prices’ break-up accounts for taxes like excise duties, customs duties and VAT. While the centre’s excise duty hike on the fuels was absorbed by the oil marketing companies, the VAT hike by the states led to an increase in retailing price.
  • The price hike on the fuels have largely off-set the leeway garnered from the global decline in oil prices.
  • Excise duty on liquor is 3rd largest SOTR. The continued dependence on alcohol as a revenue source by the states would be a disincentive for measures to cure the alcoholism issue of society.
  • There are 16 crore alcohol consumers in India, accounting for 14.6% of the 10 to 75 years age group of India’s population. India has 5.7 crore problem users and 2.9 crore dependent users.
  • The outright ban on the sale of liquor brought in unsavoury results – increase in unrest and mental issues among the addicts – sometimes even leading to suicides. Some have resorted to breaking lockdown norms to buy liquor from adjacent states, increasing the risk of COVID-19 spread.
  • On the other hand, the opening of the liquor stores had affected social distancing norms and adding management burden on the frontline workers.
  • Attaching conditions to the Centre’s measures for the states is being frowned upon as ill-timed.

What is the way forward?

  • There has been a call to expedite the transfer of GST compensations.
  • There were also entreaties to raise the fiscal deficit limits from 3% to 4.5%-5%.
  • During the lockdown period, 40% of the economy was still functional and hence the states didn’t face a complete dry-up of revenues. With the gradual easing of the lockdown restrictions, the revenue inflows are expected to improve.
  • The reforms put forth by the centre as conditions for availing the increased borrowing limit could serve as an opportunity for bringing in much-needed changes in various sectors. It could be seen as ‘not wasting a good crisis’.
  • The states have an unsustainable level of outstanding dues of distribution utilities. Hence the power sector reforms could help ease this burden. Doing away with free electricity for agriculture could cut down groundwater overuse in addition to reducing the burden on states. This, however, requires political will.
  • Finance Commissions over the years have called for realistic levy of user charges with limited and focused subsidies and empowering of local bodies and panchayats. They have great potential in revenue generation.
  • Property tax and raising revenue from vacant lands are possible avenues. Also increasing the institutional capacity of local bodies would enable them to issue municipal bonds to raise revenue.
  • Since the centre can borrow at a cheaper rate than the states, the Government of India can on-lend its market borrowings to the states. Though this will increase the centre’s fiscal deficit, it will not increase the centre and states’ combined fiscal deficit. The lower interest burden would also lower future fiscal burden.
  • The country faces the threat of GDP contraction for the first time in 4 decades. Hence, the centre must spend without worrying much about fiscal responsibility.
  • There is a need for state-centre co-ordination to overcome the crisis and transition over to the new system.
  • The institutional vacuum due to lack of a proper platform for the states to discuss such liquidity issues with the centre could be addressed if the NITI Aayog steps in to fill the role.

Conclusion:

While several countries like Germany have resorted to large scale and relatively liberal spending to tide through the COVID-19 crisis and the Great Lockdown, India cannot afford to match up to their levels given our financial limitations. The crisis has greatly aggravated the state finances, leading to serious concerns over impediments to their implementation of various measures for the people. There is a need for targeted spending at the state level and appropriate support to the states from the centre to overcome a difficult period. This is one of those times when our quasi-federal polity can prove to be an advantage (compared to the political scuffle in US administration because of the disruption between its strong centre and disjointed states).

Practice question for mains:

Discuss the issues plaguing states’ revenue sources in the light of COVID-19. (250 words)

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