Unravelling Kerala’s revenue woes

It has been a while since a war of words started between the Government of Kerala and the Union government on the reasons for the precarious state of Kerala government’s revenues. Whereas Kerala has blamed the Centre’s stepmotherly attitude towards it in allocating central financial transfers and in granting permission for public borrowing as the primary reasons for its revenue woes, the Centre has stated that the recommendations of the Finance Commission on the devolution of funds have been followed, and there is no due held back.

While conceding with Kerala’s official stand against the Narendra Modi-led National Democratic Alliance (NDA) government, the Congress-led United Democratic Front (UDF) opposition in the state has alleged that Kerala’s failure to adequately mobilise its own tax revenues was another prime reason for the state's revenue woes.

Where lies the truth? A closer analysis of long-term trends in Kerala government’s revenue receipts from 2011-2012 to 2021-2022 (actuals) reveals no one answer to this question.

Increase in grants-in-aid

As a percentage of the Gross State Domestic Product (GSDP), between 2011 and 2022, Kerala’s total revenue receipts (total revenue) have consistently been lower than the all-India average up to 2.29 percentage points (pp). However, Kerala’s total revenue-GSDP ratio increased at a higher rate of 1.5pp than the all-India average of 0.56 pp from 10.57 per cent in the triennium ending (TE) 2013-2014 to 12.09 per cent in TE 2021-2022.

Interestingly, this increase in total revenue of Kerala and other states taken together was contributed by the rise in resource transfers from the Centre to the states and not increased by the states’ revenues. Central transfers to Kerala increased to 4.68 per cent of GSDP in TE 2021-2022 from 2.52 per cent in TE 2013-2014. Notably, the rate of increase in central transfers to Kerala was higher (2.17 pp) than the all-India average (1.48 pp).

The increase in the central transfers to Kerala was contributed by a significant increase in the grants-in-aid received from the Centre. It increased from 8.34 per cent of Kerala’s total revenue in TE 2013-2014 to 23.34 per cent in TE 2021-2022. The contribution of the share in central taxes declined marginally from 15.48 per cent to 15.10 per cent of Kerala’s total revenue during the same period. However, for the states, the contribution of both central transfer components has increased, with the increase in grants-in-aid being relatively more significant.

Central transfers

One key concern with central financial transfers to Kerala is the significantly lower quantum of transfers received than the national average. Whereas the states received 48.51 per cent of their total revenue through central transfers in the TE 2021-2022 on average, Kerala received only 38.44 per cent. The contribution of the share in central taxes to the combined revenue of all the states was higher by 7.79 pp and 9.82 pp, respectively, in TE 2013-2014 and TE 2021-2022. Kerala’s share in net proceeds of all the shareable central taxes recommended by the Finance Commission declined from 2.35 per cent during 2010-2015 to 1.93/1.94 per cent during 2020-2024.

These trends point out two problem areas in the financial support granted to Kerala by the centre. First, Kerala receives a significantly less share in overall central financial transfers and shareable central taxes than the national average. Second, there seems to be a growing attempt by the Centre to channel its financial transfers to the states more through the grants-in-aid route, which restrains the freedom of the states to spend the transfers according to their expenditure priorities.

Nothing to boast about

While central financial transfers to Kerala have increased in an undesirable manner, the state’s own revenue mobilisation performance has nothing to boast about. Kerala's own revenues have declined from 8.06 per cent of GSDP in TE 2013-2014 to 7.4 per cent in TE 2021-2022. As a percentage of total revenues also, Kerala’s revenues declined sharply from 76.17 per cent to 61.56 per cent during the same period, which is almost double the rate at which the state’s own revenue declined at an all-India level.

The decline in Kerala’s own revenues was caused by the fall in its own tax revenue from 7.08 per cent of GSDP in TE 2013-2014 to 6.21 per cent in TE 2021-2022. At the all-states level, the own tax revenue-GSDP ratio has declined from 6.21 per cent to 5.99 per cent during the same period. The contribution of own non-tax revenue, on the other hand, increased slightly in Kerala between TE 2013-2014 and TE 2021-2022 as a ratio of GSDP.

Declining trend in own tax revenues

The decline in the own tax revenue-GSDP ratio in Kerala and other states was contributed by declining revenue yields from all major sources of the state’s own tax revenues, namely sales tax and VAT/GST, state excise duties, and taxes on vehicles. Kerala’s dependence on sales tax and VAT/GST to mobilise its own tax revenues has been higher than the all-state average by over 10 pp. In TE 2021-2022, Kerala mobilised close to 80 per cent of its own tax revenue from this source compared to the all-state average of 64.54 per cent. The contribution of sales tax and VAT/GST in the total revenue of Kerala declined sharply by 9.45 pp from 50.48 per cent in TE 2013-2014 to 41.03 per cent in TE 2021-2022. Though a similar trend was witnessed at the all-India level, the rate of decline was less steep, from 32.27 per cent to 29.43 per cent.

The growth rate of revenue from sales tax and VAT/GST in Kerala has declined sharply from 10.03 per cent during the five years before GST implementation (2012-2013 to 2016-2017) to just 3.21 per cent in the five years after GST implementation (2017-2018 to 2021-2022). Almost a similar trend was evident at the all-state level as well. The primary reason for the decline in sales tax and VAT/GST growth is the negative growth of states’ revenue from this source in 2019-2020 and 2020-2021. During the pandemic year 2020-2021, sales tax and VAT/GST revenue growth declined sharply to around 6 per cent in Kerala and all of India.

At a low level

Except for revenue from the sale of state lotteries, which constituted over 70 per cent of Kerala’s own non-tax revenues in TE 2021-2022, the contribution of other non-tax revenue sources, namely dividends and profits on equity investments in state public sector enterprises and statutory corporations and user charges on public goods and services in Kerala’s total revenue has declined between TE 2013-2014 and TE 2021-2022 from an already low level. The negligible and declining contribution of dividends and profits is unwarranted, considering that many budgetary funds are allocated for the PSEs. User charges are low and not revised, commensurate with the rising cost of supplying public goods and services.

To sum up, Kerala’s total revenues increased higher than the all-India average between TE 2013-2014 and TE 2021-2022 due to higher resource transfers from the Centre. The concerns with central transfers are limited to the significantly lesser quantum of transfers received by Kerala compared to the national average, and the loss of the state’s discretion in spending the financial transfers. On its part, the state has not fully utilised its tax and non-tax revenue potential. The Covid-19 pandemic, transition to GST, loss of tax autonomy due to GST adoption, and lack of adequate revenue mobilisation effort on Kerala’s part could have contributed to the unimpressive own revenue collection performance.

(Sthanu R Nair teaches Economics and Public Policy at the Indian Institute of Management Kozhikode. Views expressed are personal.)

Disclaimer: The views expressed above are the author's own. They do not necessarily reflect the views of DH.