Azim Premji University Report Highlights Growing Fiscal Burden on States in Financing India's Expanding Welfare Architecture

Recent Developments:

• The Azim Premji University report titled "Realising Rights: A Handbook of Welfare in India" highlights that State Governments finance a disproportionately large share of India's welfare expenditure despite shrinking fiscal autonomy and increasing dependence on Union transfers.
• The report argues that growing reliance on Centrally Sponsored Schemes (CSS), declining effective tax devolution, expansion of cesses and surcharges, and reduced taxation autonomy after Goods and Services Tax (GST) have widened Centre-State fiscal imbalances.
• It recommends strengthening Cooperative Fiscal Federalism through higher untied transfers, rationalisation of CSS, stronger State Finance Commissions (SFCs), protection of States' revenue powers and adoption of the Funds-Follows-Functions principle.

Evolution of India's Welfare Regime:

State-Led Welfare Phase (1950s–1980s):

• Welfare policy was closely linked with planned economic development, poverty alleviation and rural transformation through direct State intervention.
• Major initiatives included the Community Development Programme (1952), Integrated Child Development Services (ICDS) (1975) and the Minimum Needs Programme (1975), which expanded access to education, health, nutrition and rural infrastructure.

Targeted Welfare Phase (1990s):

• Economic liberalisation and fiscal constraints shifted welfare policy from universal subsidies towards targeted assistance for vulnerable groups.
• Schemes increasingly differentiated beneficiaries using poverty-based criteria, including the Targeted Public Distribution System (TPDS) introduced in 1997, based on Below Poverty Line (BPL) and Above Poverty Line (APL) classifications.

Rights-Based Welfare Phase (2000s–2014):

• Welfare gradually evolved into a framework of legally enforceable entitlements, making governments accountable for service delivery.
• Landmark legislations included the Right to Information Act, 2005, Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA), 2005, Right of Children to Free and Compulsory Education Act, 2009, and the National Food Security Act (NFSA), 2013.

Technology-Driven Welfare Phase (Present):

• Digital governance transformed welfare delivery through the Jan Dhan–Aadhaar–Mobile (JAM) Trinity and Direct Benefit Transfer (DBT) architecture.
• Schemes such as Pradhan Mantri Kisan Samman Nidhi (PM-KISAN) increasingly focus on direct income support, reflecting a shift from entitlement-based welfare towards beneficiary-oriented welfare delivery.
• Technology has improved transparency, reduced leakages and enabled targeted benefit delivery while expanding financial inclusion.

Current Status of Welfare Expenditure in India:

Coverage Expansion with Limited Fiscal Commitment:

• Welfare programmes have expanded significantly, with approximately 14 lakh Anganwadi Centres operating across the country and subsidised food grains reaching more than 81 crore beneficiaries.
• Despite this expansion, public expenditure on welfare remains below several recommended policy benchmarks.

Social Security Expenditure Gap:

• Combined expenditure of the Union and States on welfare accounts for nearly 7% of Gross Domestic Product (GDP) and around 21% of total public expenditure.
• Although India's Tax-to-GDP Ratio is comparable to many middle-income countries, expenditure on social protection remains relatively low as a proportion of GDP.

Centre-State Fiscal Asymmetry in Welfare Financing:

Disproportionate Welfare Responsibility of States:

• Combined allocations for selected welfare sectors during Financial Year 2025–26 amount to nearly ₹24.20 lakh crore, equivalent to about 6.77% of GDP.
• The Union Government contributes only around 1.89% of GDP, while States finance the majority of welfare expenditure.

Declining Effective Tax Devolution:

• The 14th Finance Commission recommended 42% tax devolution to States, while the 15th Finance Commission recommended 41%.
• However, effective devolution has remained around 29–32% because a growing share of Union tax revenue is collected through cesses and surcharges, which are excluded from the divisible pool.
• The share of cesses and surcharges increased from nearly 10.4% of Gross Tax Revenue in 2011–12 to more than 20% by 2021–22, reducing the untied resources available to States.

Growing State Expenditure on Social Services:

• States account for nearly 75.2% of total expenditure on school education, making them the principal financiers of public education.
• States also bear substantial expenditure on public health, nutrition, food distribution and unconditional cash transfer schemes.
• According to the 16th Finance Commission, States spend approximately ₹4.14 lakh crore annually on unconditional cash transfers, significantly increasing their fiscal obligations.

State Innovations and Fiscal Challenges:

States as Laboratories of Welfare Innovation:

• Several successful national welfare programmes originated as State-level initiatives before being adopted by the Union Government.
• RythBandhu of Telangana and KALIA of Odisha provided the policy foundation for PM-KISAN.
• Tamil Nadu's Mid-Day Meal Scheme later evolved into the national PM POSHAN programme.
• Despite pioneering innovative welfare models, fiscally active States often face borrowing restrictions and fiscal deficit constraints.

Challenges Associated with Centrally Sponsored Schemes (CSS):

Fiscal and Administrative Concerns:

• Many schemes such as Integrated Child Development Services (ICDS) and Pradhan Mantri MatrVandana Yojana (PMMVY) operate under a 60:40 Centre-State funding pattern, requiring States to mobilise matching resources.
• Proposed changes in rural employment programmes are expected to increase the financial contribution required from States.
• Release of Central assistance is frequently linked to policy reforms or mandatory implementation conditions, reducing States' fiscal flexibility.
• Under the PM SHRI Scheme, States were required to sign a Memorandum of Understanding (MoU) with the Union Government before receiving financial assistance, leading to concerns regarding federal autonomy.

Impact of Goods and Services Tax on Fiscal Federalism:

Reduction in Revenue Autonomy:

• The introduction of Goods and Services Tax (GST) subsumed several major State taxes, limiting States' independent taxation powers.
• States now depend significantly on the GST Council, Central tax devolution and compensation mechanisms for revenue stability.
• This has created a structural imbalance between constitutional expenditure responsibilities and available revenue sources.

Emergence of Fiscal Dependency:

• Shrinking untied transfers, tied CSS assistance, reduced taxation autonomy and borrowing restrictions have increased States' dependence on Union-controlled fiscal instruments.
• Such trends risk transforming Cooperative Federalism into a system of Coercive Fiscal Federalism, where expenditure responsibilities are decentralised but financial autonomy remains centralised.

Constitutional and Institutional Framework:

Relevant Constitutional Provisions:

• Article 246A provides concurrent taxation powers to Parliament and State Legislatures for GST.
• Article 270 governs distribution of taxes between the Union and the States.
• Article 275 provides for statutory grants-in-aid to States.
• Article 280 establishes the Finance Commission to recommend tax devolution and grants.
• Article 279A establishes the GST Council as the institutional mechanism for cooperative fiscal decision-making.
• Article 293 regulates State borrowing from the Union Government.

Measures Required to Reduce the Welfare Burden on States:

Strengthening Fiscal Federalism:

• The share of cesses and surcharges should be rationalised and confined to specific, temporary purposes to preserve the integrity of the divisible pool.
• Centrally Sponsored Schemes should undergo periodic rationalisation, with greater reliance on untied grants and flexible funding.
• The recommendation of the Punchhi Commission (2010) that CSS should remain limited to matters of national importance deserves greater implementation.
• A statutory Fiscal Council, as recommended by the N.K. Singh Fiscal Responsibility and Budget Management Review Committee (2016), should independently assess fiscal sustainability and improve Centre-State fiscal coordination.
• Residual taxation powers of States should be protected to preserve fiscal autonomy in the post-GST framework.
• Fiscal transfers should better reflect differences in revenue capacity, demographic pressures, developmental needs and welfare expenditure across States.
• State Finance Commissions (SFCs) should be constituted regularly and their recommendations implemented in a time-bound manner to strengthen fiscal decentralisation.
• Panchayati Raj Institutions (PRIs) and Urban Local Bodies (ULBs) should receive greater authority to mobilise property taxes, user charges and other local revenues.
• Institutional forums such as the Inter-State Council, Finance Commission and GST Council should facilitate continuous political dialogue on fiscal issues.
• Fiscal transfers should increasingly follow the Funds-Follows-Functions principle, ensuring that revenue powers correspond to expenditure responsibilities.

Important Judicial Developments:

Recent Supreme Court Judgments:

• The Mineral Area Development Authority (MADA) v. Steel Authority of India Limited (SAIL), 2024 judgment reaffirmed significant State taxation powers relating to mineral rights.
• The State of Uttar Pradesh v. Lalta Prasad Vaish, 2024 judgment reinforced constitutional protection for State taxation powers relating to industrial alcohol.
• These decisions strengthen the principle that constitutionally assigned State revenue sources should not be unduly diluted.

UPSC Relevance:

GS Paper II:

• Centre-State Relations, Fiscal Federalism, Finance Commission, Cooperative Federalism, Governance, Welfare Policies.

GS Paper III:

• Inclusive Growth, Public Finance, Fiscal Policy, GST, Social Sector Financing, Economic Development.

Prelims Pointers:

• Finance Commission is constituted under Article 280.
• GST Council is established under Article 279A.
• Article 270 governs distribution of Union taxes.
• State Finance Commissions are constituted under Articles 243-I and 243-Y.
• Cesses and surcharges do not form part of the divisible pool of taxes shared with States.

Value Addition for UPSC:

Key Concepts and Committees:

• Vertical Fiscal Imbalance refers to the mismatch between revenue-raising powers and expenditure responsibilities across different levels of government.
• Horizontal Fiscal Imbalance refers to differences in fiscal capacity and expenditure needs among States.
• The Second Administrative Reforms Commission, Punchhi Commission, and successive Finance Commissions have consistently emphasised strengthening Cooperative Fiscal Federalism through greater fiscal autonomy, predictable devolution and institutional dialogue.
• Sustainable welfare financing requires balancing macroeconomic stability, fiscal responsibility, State autonomy, and equitable social sector investment, thereby ensuring effective implementation of the Directive Principles of State Policy (DPSPs) while preserving India's federal constitutional structure