The Case of Revenue versus Expenditure Optimization in India

This paper investigates the revenue-expenditure relationship in context of central and general category states in India. In particular the analysis is pertaining to the time period, 1973-2011. Unit root test in the presence of structural breaks is employed to determine the order of integration and accordingly co integration and causality tests are applied to determine inter temporal relationship between revenue and expenditure streams. The key findings are as follows: Firstly, there exists an institutional separation between expenditure and revenue streams at the Central Government level implying the tendency towards permanent deficit finance. Secondly, in majority of the States, tax and spend hypothesis has been upheld in case of own revenue and expenditure indicating that the size of the government at the state level is determined by the resource supply and not by expenditure demand. Thirdly, In case of relationship between Central transfers and expenditure, in most of the poorer states there is causality from Central transfers to expenditure and vice versa in the better off States. Prima facie, from the results it is striking that this study refutes the prevailing wisdom that States are fiscally profligate and call for a discussion whether to empower states with further fiscal responsibilities? Given the existing dynamics of spending there is a scope for rationalizing Central Government expenditure and a greater accommodation for states in the development spending as states understand priorities well and being closer to their constituents they could foster effective spending and better public service delivery.