Revenue–expenditure nexus of Indian states: panel ARDL approach

Purpose In India’s federal system, rising expenditure responsibilities and limited tax-raising powers challenge states’ fiscal stability. Analyzing the short- and long-term revenue–expenditure nexus and identifying fiscal consolidation strategies is crucial to managing fiscal deficits effectively. Design/methodology/approach The present study delves into the short- and long-term causal relationships between state expenditures and taxes, utilizing panel data from 29 Indian states. The use of panel autoregressive distributed lag. Findings The estimates confirm that the growth of state government spending and state government income (state gross domestic product) positively impacts state government taxes. Therefore, these findings lend support to the spend-tax hypothesis, both in the short run and long run. The estimates of spend-tax causality also suggest that states may not necessarily need to be concerned about controlling their expenditure and increasing fiscal deficits. Practical implications States in India can garner the necessary financial resources through either their own taxes or their share in central taxes to fulfill their expenditure needs. This, indeed, is an advantage of the federal system. Originality/value The outcomes of this investigation also prompt the necessity for a fresh assessment of the spend-tax hypothesis utilizing the variables of state expenditure and states’ owned tax income, excluding any form of central transfers. This study can be further added to the literature on causal link between expenditure and states’ own revenue in India and also reevaluate the progression of fiscal decentralization in the country. Peer review The peer review history for this article is available at: https://publons.com/publon/10.1108/IJSE-03-2024-0232