Whether by accident or design, governments, at both the central and state levels, are being hemmed in. This shackling of the general government has occurred slowly – first, by the lowering of the corporate taxes in 2019, then by the rejigging of personal income tax slabs in the Union budget 2025-26, and now by the rationalisation of GST slabs. The net impact of these fiscal steps — even as the direct and indirect tax base has significantly expanded over the past decade — is constrained finances, forcing governments to restrain expenditure, despite the bluster of lavish spending.
The estimates of the extent of revenue foregone due to these tax cuts vary considerably. Nonetheless, they are quite significant. For the corporate tax cuts, the initial estimates pegged the revenue foregone at Rs 1.45 lakh crore, while in the case of the income taxes, it was around Rs 1 lakh crore. For GST, while precise estimates are difficult to arrive at, they will reflect slowly in tax collections.
This shackling of the general government is clearly visible. Over the past decade, the Centre’s tax collections have barely inched upwards – net tax revenues were 7.2 per cent in 2014-15 and were budgeted at 7.9 per cent in 2025-26. Collections may, in fact, end up being lower this year. And while states have seen their revenues edge slightly upwards, the lowering of GST rates will now affect their own tax collections, even as the direct tax cuts, along with the imposition of cesses and surcharges, are affecting transfers from the central government.
Whether these tax cuts were announced due to ideological considerations or political or economic imperatives – driven by the desire to boost private consumption and investment, and reduce middle-class disenchantment – the effect has been a shift to a lower tax regime. And the constrained state that governments find themselves in is reflected in their budget allocations.
Take the case of PM-Kisan. In 2020-21, actual spending under the scheme was Rs 60,989 crore or 0.30 per cent of GDP. In 2025-26, the budgeted allocation was Rs 63,500 crore or 0.18 per cent of GDP — a fall in relative terms. Overall, the Centre’s expenditure to GDP ratio, which was around 13.3 per cent in 2014-15 and rose during the Covid years, was budgeted at 14.2 per cent in 2025-26. It might actually end up being lower in the revised estimates. During these years, fiscal consolidation has been achieved by expenditure compression, not significant revenue enhancement.
The effects are visible at the state level as well. Take, for instance, the cash transfer schemes. There has been some apprehension that the sharp explosion in such populist schemes would worsen their revenue balances and leave fewer resources for capital spending. However, that has not completely been the case. As per ICRA’s estimates, some states have reduced spending under other heads to create space for these cash transfers, indicating the constraints of finances.
The changes to the funding structure under MGNREGA, now VB-G RAM G, will further squeeze the fiscal space available to states as under the new framework they have to fork out 40 per cent of the costs incurred. If this template of reconfiguring the funding shares of the Centre and states is extended to other schemes, then the elbow room available to states will shrink further.
In an environment of competitive populism, this shackling of governments limits the ability of the political class to adopt populist schemes. Further, as these tax cuts will be difficult to reverse, considering the political economy, the revenue constraints are not limited to this period alone, but are more long-term in nature. This implies that not only current governments, but future ones are also likely to be hemmed in. Unless, of course, growth takes off.
There are two imponderables. One, what will be the 16th Finance Commission’s recommendations on the division of the tax pool between the Centre and the states? Considering the limited resources, any division will leave one side less satisfied and more boxed in. And two, to what extent will the Pay Commission award increase the fixed outgo for governments, further restricting the space for spending on other areas?
All this suggests that a minimum government may well be on its way. Maximum governance, that’s another story.
Till next time,
Ishan Bakshi
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