See All Articles

Freebies Are Not India’s Fiscal Villain — The Real Problem Is How States Pay for Them

Every election season, a familiar script plays out. Political parties dangle cash transfers, free electricity, and subsidized services before voters, while commentators sound the alarm: India’s states are hurtling toward a debt crisis, driven by populist freebies. But the widely accepted narrative masks a more complex reality. When you look beyond the political noise and examine the data, India’s state finances tell a story that is both reassuring and deeply troubling — not because of the freebies themselves, but because of the way they are being financed.

The Fiscal Deficit Mirage

For years, the combined fiscal deficit of all states has hovered around the 3% of GDP mark, excluding the pandemic shock. That’s well within the borrowing limits set by fiscal responsibility laws. If you stop there, the alarm bells seem false. States, as a whole, appear disciplined. But focusing on the headline deficit is misleading. To understand the real fiscal health, you have to dig into how the borrowing is being used.

Revenue vs. Capital: The Crucial Divide

Borrowing to build a road, a hospital, or an irrigation project is fundamentally different from borrowing to pay salaries, pensions, or welfare bills. The first creates assets that can spur future growth and generate returns. The second simply finances today’s consumption. This is where the concept of the revenue deficit comes in — the gap between a state’s current income and its current spending. A state that runs a revenue deficit is effectively taking on debt to cover its day-to-day expenses. A state with a revenue surplus, even if it has a high fiscal deficit, is borrowing primarily for capital formation.

The good news is that, taken together, Indian states have kept their combined revenue deficit below 1% of GDP for most of the past fifteen years, and they even ran a revenue surplus for three of those years. This aggregate picture suggests that much of the borrowing has been channelled into productive assets. But national aggregates are dangerous things; they hide glaring state-level fissures.

The Stark Divides Between States

A handful of states — Punjab, Himachal Pradesh, West Bengal, Kerala, and Rajasthan — stand out. Their debt levels are well above the comfort zone, and most of them are also running sizable revenue deficits. That means a significant portion of their borrowing is being consumed by salaries, pensions, and interest payments, leaving very little room for capital spending. It is in these states that the warning about freebies begins to find real traction, because welfare promises are increasingly being met through borrowed money rather than through tax buoyancy or expenditure rationalisation.

Contrast that with Odisha. On the surface, Odisha projects a relatively high fiscal deficit, yet it has consistently maintained a revenue surplus for years. It funds its welfare schemes largely from its own revenues. The fiscal deficit, in Odisha’s case, is a sign of investment, not profligacy. Maharashtra presents yet another picture: its total debt is still within manageable limits, but its revenue deficit has been swelling, partly due to welfare spending. It’s a warning sign that even a relatively comfortable state can drift into precarious territory if it loses sight of the revenue-capital distinction.

The lesson here is blunt: freebies alone do not determine a state’s fiscal health. What matters is the quality of the financing behind them.

The Rapid Rise of Unconditional Cash Transfers

This distinction has become urgent because of the breakneck expansion of unconditional cash transfer schemes. Their combined cost has skyrocketed from just 0.01% of GDP in FY21 to a projected 0.57% in FY26. The number of states offering such schemes has grown from one to twelve in the same period. Every new promise widens the scrutiny on state finances, because the fiscal room to accommodate these doles must come from somewhere. If they are paid for out of buoyant revenues, they remain sustainable. If they are added to an already strained revenue account, they accelerate the drift toward a debt trap.

The Real Debate

Political discourse habitually frames freebies as the villain. But that framing is lazy. The real fracture line is not between welfare and no welfare, but between states that have the revenue capacity to fund their promises and those that resort to borrowing for consumption. As long as the public debate remains stuck on the morality or electoral appeal of freebies, it misses the more urgent structural question: how can India’s federal fiscal architecture penalise revenue-deficit financing and reward states that maintain a clean revenue account? Until then, the aggregate numbers will keep lulling us into complacency while individual states silently steer toward a cliff. The real freebie, it turns out, is the lack of honesty about the quality of public finances.

Facts

• The combined fiscal deficit of Indian states has remained around 3% of GDP for over a decade, except during the pandemic.
• States have kept their combined revenue deficit below 1% of GDP for most of the last fifteen years, and even ran a revenue surplus for three years.
• Highly indebted states like Punjab, Himachal Pradesh, West Bengal, Kerala, and Rajasthan are running sizable revenue deficits.
• Odisha has projected a high fiscal deficit but has consistently maintained a revenue surplus.
• Maharashtra’s debt is still manageable, but its revenue deficit has been rising.
• The cost of unconditional cash transfers by states rose from 0.01% of GDP in FY21 to 0.57% in FY26; the number of states offering such schemes increased from 1 to 12.

Criticisms

• You, the political class, weaponise freebies as a vote-buying mechanism without coupling them with the revenue reforms needed to foot the bill sustainably.
• State governments whose finances are frayed hide behind the comfortable all-states average, dodging accountability for their revenue deficits.
• Mainstream commentary and media coverage routinely equate all welfare spending with fiscal irresponsibility, ignoring the fundamental difference between capital investment and revenue consumption.
• The current fiscal responsibility framework fails to penalise revenue-deficit financing strongly enough, creating a moral hazard that rewards short-term populism.
• No central agency or institution provides a clear, standardised public metric that separates states borrowing for assets from states borrowing for salaries — a gap that lets fiscal decay fester in plain sight.