Tamil Nadu's Fiscal Health Paradox: A Deep Dive into Economic Success and Fiscal Challenges
By most visible measures, Tamil Nadu's economy stands as a remarkable success story. The state is among the fastest-growing in India, ranking first in Gross State Domestic Product (GSDP) growth and second in its contribution to the national GDP. On the social front, it boasts the highest enrolment in higher education and the second-lowest poverty ratio, showcasing robust development outcomes.
NITI Aayog's Fiscal Health Index Reveals Contradictions
However, a recent report from NITI Aayog paints a contrasting picture. The Fiscal Health Index (FHI) for 2023-24, released in 2026, places Tamil Nadu at 13th among 18 general category states, with a score of 29.8%. This ranking is lower than its ninth position in the horizontal devolution formula by the Sixteenth Finance Commission (SFC), highlighting a significant discrepancy.
The state's fiscal performance appears incongruous given its strong economic and social metrics. Experts suggest that Tamil Nadu may be allocating fiscal resources to support growth and welfare initiatives rather than focusing on strict fiscal consolidation, which could explain the lower ranking.
Declining Fiscal Health Over the Decade
Although Tamil Nadu's FHI score saw a slight increase from 29.2% in 2022-23, its rank declined from 11th to 13th, moving from the 'Performer' category to 'Aspirational'. This shift indicates emerging fiscal pressures that warrant attention.
The FHI is a data-driven framework designed to assess fiscal performance, identify vulnerabilities, and support evidence-based policymaking at the state level. It is built on five pillars and nine sub-indicators, including:
- Development expenditure to total expenditure
- Capital expenditure to GSDP
- Own revenues to GSDP
- Own revenues to total expenditure
- Fiscal deficit to GSDP
- Revenue deficit to GSDP
- Interest to revenue receipts
- Outstanding liabilities to GSDP
- Gap between GSDP growth and interest payment growth
The index uses the Linear Scaling Technique to standardise indicators, with each score ranging from 0 to 1, and all indicators are assigned equal weights.
Longitudinal Analysis Shows Deterioration
The report analyses fiscal trends over a decade, from 2014-2015 to 2023-2024, revealing a concerning decline in Tamil Nadu's fiscal health. During 2014-15 to 2016-17, the state ranked 9th with a score of 40.5%, but this dropped to 15th with a score of 31.5% during 2017-2018 to 2019-2020.
Key scores have shown significant fluctuations:
- Quality of expenditure: Declined from 33.6% (2014-2015 to 2016-2017) to 25.1% (2017-2018 to 2019-2020), with a brief recovery to 30.5% in 2023-2024.
- Revenue mobilisation: Fell steadily from 49.9% to 39.8% over the same period.
- Fiscal prudence: Dropped from 29% to 15.3%, before settling at 21.5% in 2023-2024.
- Debt index: Went from 76.5% to 39.1%, with the debt sustainability index falling to 18.2% in 2023-2024, indicating rising fiscal stress.
High Debt Servicing Burden and Borrowing Trends
Interest payments accounted for a quarter of Tamil Nadu's committed expenditure, highlighting a high debt servicing burden. Outstanding liabilities increased by 11.6% over the previous year, while public debt grew by 14.2%, reflecting continued borrowing to finance expenditures and meet fiscal requirements.
Implications for Tax Devolution and Policy
The report underscores the importance of strong state finances for macroeconomic stability, calling for better tax mobilisation, tighter control of committed expenditure, higher capital spending, and stronger fiscal discipline. However, the FHI has limitations, such as assigning equal weights to all pillars, which may not accurately reflect priorities like macroeconomic stability and tax capacity.
Furthermore, development expenditure includes capital expenditure, potentially leading to double counting within the quality of expenditure pillar. The index also fails to account for the outcomes of fiscal policies, such as how education expenditures have increased higher education enrolment.
Discrepancies with Finance Commission Allocations
Under the SFC's devolution formula, Tamil Nadu ranks 9th with a horizontal share of about 4.1%. However, discrepancies emerge when comparing these allocations with FHI rankings. For example, Odisha ranks first in FHI but 12th in SFC ranking, receiving a 4.4% share. Similarly, Uttar Pradesh ranks 8th in FHI but 18th in SFC, receiving the largest share at 17.6%, and Bihar ranks 12th in FHI but 17th in SFC, receiving the second-largest share at 9.9%.
These differences arise because the SFC relies on indirect proxies rather than direct measures of fiscal performance. If the SFC had used the FHI ranking criterion, Tamil Nadu's share of central taxes could potentially rise from 4.1% to about 6%. This increase would translate into a substantial gain, amounting to approximately ₹1.9 lakh crore over the award period, or roughly ₹38,040 crore more each year.
Call for Refinement and Future Considerations
There is a pressing need to refine the Fiscal Health Index to better assess states' fiscal performance and consider its use as a criterion for tax devolution. By addressing its limitations and incorporating outcome-based metrics, the index could provide a more holistic view of fiscal health, aligning economic success with financial stability.
Insights contributed by K R Shanmugam, former director of Madras School of Economics, and Saumitra N Bhaduri, professor at MSE.
