Study claims Indian states follow a flawed ‘spend-tax’ model to overcome fiscal issues

A new study analyzing the revenue-expenditure nexus of Indian states has revealed that state government spending drives tax revenue growth, supporting the ‘spend-tax’ hypothesis. Conducted by researchers Himani Baxi and Dhyani Mehta from Pandit Deendayal Energy University, the study used a panel Autoregressive Distributed Lag (ARDL) approach -- statistical technique used to analyze the long-term relationship between variables -- to examine fiscal trends across 29 Indian states from 1990 to 2022.

The research found that state expenditure positively impacts tax revenue in both the short and long run. A 10% increase in state spending leads to a 1% rise in tax revenue in the short term and an 1.8% increase in the long term. Additionally, state GDP growth significantly boosts tax revenue, with a 10% rise in GDP resulting in a tax revenue increase of 8% over the long term.

The findings challenge conventional fiscal theories that suggest taxation should determine spending. Instead, Indian states appear to spend first and then generate tax revenue to match expenditure needs. This contrasts with studies in other countries, where the tax-spend or fiscal synchronization models are more commonly observed.

However, the study highlights concerns over states’ growing dependence on central government tax transfers, which may weaken fiscal autonomy. It suggests that states should explore alternative revenue sources, such as non-tax revenues, and focus on efficient public service pricing to reduce dependency on central funds.

With rising infrastructure costs and the reintroduction of old pension schemes, the Reserve Bank of India has warned that controlling fiscal deficits will be increasingly difficult. The study emphasizes the need for a re-evaluation of fiscal decentralization policies to ensure sustainable state finances.

The research has been published in the International Journal of Social Economics and is expected to influence future discussions on state-level fiscal policies in India.

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Jay Somnath

Kanhaiyalal Maneklal Munshi This is what happened several decades ago, when I was a small school-going child. Every summer, accompanied with my mother, I would come down from Delhi to spend the two-month-long holiday at my maternal uncle’s place in the posh Panchvati area of Ahmedabad. Each weekend, my uncle would take us for a ride in his grand old black car. I think it was Chevrolet. I would wait eagerly for the weekend, as I had virtually nothing to do for the rest of the days. In the evenings, I mostly play in the open ground with the neighbouring children, but for rest of the time, as if, I was under strict, almost loving, control of my grandma, whom all of the children of the family called Baa. Especially after the dinner, which would be pretty early, she would make it a point to entertain us – mainly me and my cousin – by playing bezique. During one such summer, Baa decided to give us a strong injection of nationalism. She took in her hand Kanhaiyalal Maneklal Munshi’s well-kno...

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