How State Governments Raise and Spend Money

Where Indian state governments get their revenue, what they spend it on, and the role of GST, Finance Commission transfers and state borrowing.

Indian states spend more than the central government on many services that directly affect citizens. Understanding state finances helps explain differences in public services.

Sources of revenue

State taxes: states’ own taxes include their share of the Goods and Services Tax, stamp duties and registration fees, taxes on alcohol and petroleum products, and vehicle taxes.
Share of central taxes: the Finance Commission, a constitutional body appointed every five years, recommends what share of central tax revenue goes to states and how it is divided among them. The Fifteenth Finance Commission recommended that states receive 41 percent of the divisible pool of central taxes.
Grants from the central government, including for centrally sponsored schemes.
Borrowing, within limits approved by the central government.

How transfers are divided

The Finance Commission uses a formula that considers factors such as population, area, income distance from richer states, forest cover and demographic performance. Poorer states receive a larger share per person, helping reduce inequality between states.

GST and fiscal autonomy

When the Goods and Services Tax replaced many state and central taxes in 2017, states gave up their power to set rates on many goods, which are now decided jointly in the GST Council, where the central and state governments are represented. States were compensated for revenue losses for five years. Some states argue GST reduced their fiscal autonomy.

What states spend on

Education, health, police and agriculture.
Salaries and pensions for state employees.
Interest on debt.
Subsidies, such as for electricity.
Capital spending on roads, irrigation and infrastructure.

State debt

Some states, including Punjab, Kerala and Rajasthan, have high debt relative to their economies. The RBI and economists have raised concerns about rising debt and off-budget borrowing in some states.

A formula that redistributes

A richer state generates a large share of central tax revenue, while a poorer state generates less. The Finance Commission formula gives the poorer state a larger share of central taxes per person, allowing it to fund schools and hospitals it could not afford from its own revenue. This redistribution is a core feature of India's fiscal federalism.

Thinking states are funded only by their own taxes

Many states, especially poorer ones, rely heavily on transfers from the central government through Finance Commission devolution and grants.

Key takeaways

States raise revenue from GST, stamp duties, alcohol and fuel taxes and other state taxes.
The Finance Commission recommends how central taxes are shared; the Fifteenth recommended 41 percent.
GST in 2017 moved many tax decisions to the joint GST Council.
Some states face high debt, raising concerns about fiscal sustainability.