IAS/UPSC Coaching Institute  

30 Jan 2026 : Devolution, not debt

Article 2 : Devolution, not debt

Why in news: State governments are increasingly scrutinising the Union Budget as Central tax devolution is failing to stabilise their finances, pushing them toward higher market borrowing through State Development Loans (SDLs).

 

Key Details:

  • Union Budget relevance: States closely track the Budget to assess actual resource flows, not just headline devolution figures.
  • Shift in financing pattern: SDLs have moved from being an exceptional tool to a routine source of revenue.
  • Post-COVID stress: The pandemic shock exposed weaknesses in Central support mechanisms.
  • Hidden erosion of devolution: Rising cesses and surcharges reduce the effective share of States.
  • GST impact: Centralised tax collection has weakened the tax effort–reward link for States.
  • Rising debt burden: Increasing debt-to-GSDP ratios threaten long-term fiscal sustainability.
  • Crowding out effect: Borrowing for welfare limits funds for capital expenditure and private investment.

 

Diminishing Role of Central Tax Devolution

  • The Union Budget is closely watched by States to gauge their share of Central tax devolution, but this source is no longer providing the stability it once did to State finances.
  • Despite a constitutionally fixed share, effective resource flow to States has weakened over time.

 

Rising Dependence on State Development Loans (SDLs)

  • SDLs have become a major financing tool for States’ routine expenditure, rather than just capital needs.
  • In 2024–25 (RE), SDLs formed about 35% of Tamil Nadu’s and nearly 26% of Maharashtra’s total revenue receipts—levels earlier seen as fiscally exceptional.
  • This shift intensified after 2020–21, when the COVID-19 shock exposed the inadequacy of Central devolution.
  • The dependence on borrowing has persisted, with even profit-making State PSUs and SPVs being used to finance revenue expenditure.

 

Erosion of Effective Devolution Mechanism

  • Although the 15th Finance Commission set States’ share at 41% of the divisible pool, rising cesses and surcharges—kept outside the pool—have reduced actual transfers.
  • Industrialised States with strong indirect tax bases are especially affected.

 

Impact of GST on State Finances

  • Since the introduction of GST in 2017, a large portion of indirect taxes is collected by the Centre and redistributed through formulas that weaken the link between tax effort and reward.
  • This has constrained States’ fiscal capacity despite higher overall collections.

 

Borrowing-Led Welfare Financing

  • Key welfare commitments—such as old-age pensions, employee pensions, and mass health insurance schemes—are increasingly funded through domestic borrowing.
  • This crowds out resources for public capital expenditure and private investment, both crucial for sustaining growth.

 

Evidence from State Borrowing Patterns

  • A five-year comparison across Punjab, Uttar Pradesh, Tamil Nadu, Maharashtra, and West Bengal highlights growing reliance on SDLs.
  • West Bengal, despite receiving about 47.7% of its revenues from Central devolution, continued heavy borrowing, with SDLs averaging 35% of revenues.
  • This occurred even as nominal tax devolution increased, indicating deeper structural stress.

 

Implications for Fiscal Federalism

  • The trend signals a steady erosion of States’ fiscal autonomy.
  • Rising debt-to-GSDP ratios alongside weakening assured revenues pose serious macroeconomic risks.
  • If debt replaces devolution as the primary shock absorber, fiscal sustainability will be undermined.

 

Way Forward

  • Increase effective tax devolution, not just nominal shares.
  • Bring cesses and surcharges into the divisible pool.
  • Redesign horizontal devolution criteria to reward tax effort, efficiency, and fiscal discipline.
  • Strengthen States’ capacity for own-tax revenue mobilisation.

 

Conclusion

The growing reliance of States on borrowing instead of assured tax devolution signals a weakening of India’s fiscal federalism. As debt increasingly replaces devolution as the primary shock absorber, State finances face rising sustainability risks. Restoring effective tax transfers, reducing dependence on cesses, and strengthening fiscal autonomy are essential to protect long-term growth and macroeconomic stability.

 

Descriptive question:

Q. Critically examine how declining tax devolution and rising State borrowings affect India’s fiscal federalism. (10 marks, 150 words)