Rationale for revenue deficit

The 2025-26 Karnataka budget, announced on March 7, is the second consecutive revenue deficit budget presented by Chief Minister Siddaramaiah. Although the state’s revenue deficit decreased from Rs 27,354 crore in 2024-25 to Rs 19,262 crore this year, it continues to fall short of the Fiscal Responsibility and Budget Management (FRBM) Act’s mandate to eliminate revenue deficits in state budgets. The ongoing financial commitment to the five guarantee schemes remains the primary reason for the state’s persisting revenue deficit. This raises questions on whether it is financially imprudent of the state to propose yet another revenue deficit budget.

The idea of a state spending higher than its receipts has increasingly evoked discomfort in recent years. However, the notion that fiscal deficit is always bad is not uncontested among economists and public policy experts. A budget deficit boosts economic growth in two major ways. First, it directly introduces demand through government expenditure. Second, by not increasing tax rates to fund higher expenditure, the state does not stifle the purchasing power of the people, ensuring that two essentials for long-term economic growth i.e., private consumption and private investment remain strong.

However, if a government consistently spends beyond its means, the upcoming governments will have to spend exorbitant amounts on repayments and interest instead of spending on social welfare and infrastructure priorities.

To balance the pros and cons of fiscal deficit, by the late 1990s and early 2000s, it became popular that governments should only borrow money to invest in capital formation and not to fund day-to-day expenditures. It gained so much traction that it is referred to as the ‘golden rule of public finance.’ The FRBM Act 2003 made this golden rule legally binding on Indian states. It stipulates maintenance of the states’ fiscal deficits below 3% of the GSDP and elimination of revenue deficits.

The double standards for capital deficit and revenue deficit emerge from the idea that capital expenditure which creates long-term assets is more important for economic growth than revenue expenditure spent on operational aspects. This is not always true. Investments on building anganwadi centres, schools, and hospitals accrue to capital expenditure. However, expenditures on salaries for staffing these facilities accrue to revenue expenditure. Cutting revenue expenditure by short-staffing human resource renders the capital expenditure fruitless. Revenue expenditures on health, education, and early childhood care are necessary to increase the productive capacity of human capital. A report submitted by the Centre for Budget and Policy Studies to the state’s Finance

Department in 2020 emphasises that expenditures in these sectors should not be considered as mere consumption expenditures but as investments that generate significant economic returns.

A commitment to allocations

India is currently dealing with a well-documented demand crisis due to declining consumer demand. Revenue expenditures, especially in the form of cash transfers, increase the private consumption demand necessary for profitability of private investments, making them critical for both short-term and long-term economic growth.

The Karnataka Government’s decision to undertake a revenue deficit should be evaluated in this context. The Rs-51,034 crore allocation made to the five guarantee schemes is the main driver of the state’s high revenue expenditure. The state demonstrated its continued commitment to these schemes, despite criticism from the opposition by keeping allocations nearly unchanged from last year.

The five schemes that collectively promise each beneficiary household direct and indirect benefits amounting to an average of Rs 4,000-Rs 5,000 per month in cash transfers improve living standards and increase purchasing power. The free bus transport scheme enhances women’s mobility and independence – a crucial step towards realising their productive potential. Similarly, evidence shows that the unemployment benefit scheme can positively impact the productivity of the youth by providing support during the job search period. To summarise, the revenue expenditures that are undertaken by the state government are well within the ambit of government investments promoting long-term economic growth.

The state has adequately prioritised capital expenditure in this budget, countering criticism that the revenue expenditure on guarantee schemes comes at the expense of capital expenditure. The state has also shown prudence ensuring that its total fiscal deficit is below the recommended 3% and the share of total outstanding liabilities is less than 25%.

Public finance rules, unlike the laws of the universe, are not absolute; their impact depends on the broader economic context. In Karnataka’s case, the economic and social benefits of maintaining a revenue deficit outweigh its risks, making it a strategic choice rather than a reckless one.

(The writer is a research associate at Centre for Budget and Policy Studies)