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

By Jag Jivan   

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.