State Governments and the Union Budget

State governments are significant stakeholders in the Union Budget. Their revenues, expenditures, and deficits are influenced by the magnitude of tax devolution and grants from the central government, which account for over 40% of several states' revenues.

Tax Devolution

• Over the past five fiscal years, the actual tax devolution has significantly varied from the initially budgeted amount.
• For 2024-25, the central government increased tax devolution to Rs 12.9 trillion from an initial Rs 12.5 trillion, reflecting payments from earlier periods and an increased share in income tax revenues.
• In 2025-26, tax devolution is budgeted at Rs 14.2 trillion, an 11% increase from the previous year.
• Given the tax foregone due to modifications in personal income tax, the projections for growth in gross tax revenues may be optimistic, potentially dampening tax devolution growth.

Grants

• The growth trajectory of grants has been uneven. The end of GST compensation grants in 2022-23 and a decline in Finance Commission-recommended grants led to a 13% reduction in total grants to Rs 7.8 trillion in 2023-24.
• In 2024-25, grants were reduced by nearly Rs 1 trillion, primarily due to lower grants for centrally sponsored schemes and GST compensation.
• For 2025-26, total grants are set at Rs 8.9 trillion, marking a 14% growth, surpassing the increase in tax devolution.

Special Assistance Scheme for Capital Expenditure

• The Centre has increased allocations under the special assistance scheme as loans for capital expenditure as a resource boost for states.
• In 2024-25, the allocation for the capex loan scheme is Rs 1.25 trillion, lower than the budgeted Rs 1.5 trillion.
• All 28 states utilized the scheme in 2024-25, with Bihar, Madhya Pradesh, Uttar Pradesh, and West Bengal together availing 40% of the disbursed amount.
• The 2025-26 allocation for the capex loan scheme is set at Rs 1.5 trillion.

Conditional Borrowing and Power Sector Reforms

• The Centre extended the conditional borrowing linked to power sector reforms (0.5% of GSDP) to 2025-26.
• This extension incentivizes states to undertake crucial reforms in the power sector, essential for economic growth.
• States borrowed Rs 1.2 trillion under this framework during FY2022-24.

Union Budget Features and Future Considerations

The recent Union budget's features, such as increased untied tax devolution, higher capex loan outlay, and extended borrowing permissions, are positive for state capital expenditure. Looking ahead, states are keenly awaiting the 16th Finance Commission's recommendations concerning deficit and debt targets for FY2027-31, expected before the Union Budget 2026-27. Additionally, the continuation of the capex loan scheme and its exclusion from the net borrowing limit during the 16th FC's award period remains a point of interest.