Himachal Pradesh Budget Exposes India's Fiscal Federalism Crisis
By The Squirrels·
The Illusion of Cooperative Federalism
For the past decade, the phrase "cooperative federalism" has served as the cornerstone of the Union government's economic rhetoric, projecting an image of a unified, mutually supportive fiscal partnership between New Delhi and India's states. Yet, a forensic examination of state ledgers—most notably the 2025-26 budget of Himachal Pradesh—reveals a starkly different reality on the ground.
Across India, opposition-ruled states are raising alarms over what they describe as a systemic strangulation of state finances. The mechanisms of this squeeze are bureaucratic but devastating: delayed grants, withheld compensation, and stringent borrowing limits. When Himachal Pradesh Chief Minister Sukhvinder Singh Sukhu presented the state's 2025-26 budget in March 2025, he officially cited the cessation of Goods and Services Tax (GST) compensation and the severe tapering of the Revenue Deficit Grant (RDG) as the primary drivers of the state's financial crisis.
Is this merely routine political bickering over limited resources, or is it a symptom of a larger constitutional breakdown in India's fiscal architecture? By decoding the Himachal Pradesh budget crisis alongside nationwide data trends, a clear pattern emerges: the widening gulf between federal promises and fiscal realities is fundamentally altering the balance of power in the world's largest democracy.
The Anatomy of a Fiscal Chokehold
The fiscal squeeze on Himachal Pradesh provides a textbook case study of how structural changes in federal transfers can destabilize a state's economy. According to official budget documents and expert analyses, the state is facing a multi-front revenue collapse, driven largely by decisions made at the Union level.
The numbers paint a grim picture of the state's financial health:
The GST Revenue Cliff: Up to the 2023-2024 fiscal year, Himachal Pradesh incurred a total revenue loss of ₹9,478 crore due to the transition from the Value Added Tax (VAT) regime to GST, compounded by the end of the Union's GST compensation guarantee. The June 2022 expiration of the Centre's promise to compensate states for a 14% compounded annual growth in GST revenue triggered a massive revenue cliff for consumption-heavy and geographically constrained states.
The Tapering Deficit Grant: The state has witnessed a steep decline in its Revenue Deficit Grant (RDG). While Himachal Pradesh received ₹10,249 crore in 2021-22, this allocation has tapered down to a projected ₹3,257 crore for 2025-26.
Slashed Borrowing Limits: Between 2023 and 2024, the Centre reduced Himachal Pradesh's borrowing limit from 5% to 3.5% of its Gross Domestic Product (GDP). This administrative move shrank the state's borrowing capacity overnight from ₹14,500 crore to ₹9,000 crore, severely limiting its ability to finance capital expenditure.
Locked Pension Funds: The Himachal Pradesh government claims that approximately ₹9,000 crore of state and employee funds under the National Pension Scheme (NPS) is currently being held by the Centre via the National Securities Depository Limited (NSDL) and has not been returned.
Cumulatively, these factors have culminated in an estimated revenue deficit of ₹6,390 crore for the 2025-26 fiscal year, representing 2.5% of the state's Gross State Domestic Product (GSDP).
The Constitutional Bypass: Article 280 vs. Article 282
To understand how the Union government exercises such profound control over state finances, one must look at the constitutional architecture governing Centre-State relations. The current friction is rooted in the shifting balance between two critical constitutional provisions.
Article 280 establishes the Finance Commission, an independent, constitutionally mandated body tasked with recommending the objective distribution of tax revenues between the Union and the States. This is the bedrock of formulaic, neutral fiscal federalism.
However, Article 282 allows the Union or a State to make discretionary grants for any "public purpose." Historically, Article 282 was intended for special, temporary, or emergency schemes. As early as 1965, Justice P.V. Rajamannar of the Fourth Finance Commission warned that Article 282 should not be used for general-purpose grants, as doing so bypasses the Finance Commission's objective formulas.
Today, analysts note a heavy reliance on Centrally Sponsored Schemes (CSS) funded via Article 282. This introduces a highly political element into financial relationships, allowing the Centre to attach strict policy conditionalities to funds that states desperately need.
A Nationwide Contagion of Withheld Funds
Himachal Pradesh is not an isolated incident. The weaponization of federal funds has sparked a nationwide contagion, affecting several non-aligned states between 2023 and 2026. The data reveals a clear geographic and political divide in how federal resources are distributed and withheld.
In October 2024, Southern states, led by Karnataka and Tamil Nadu, publicly protested the Union's tax devolution formula. Official data revealed a stark disparity: Uttar Pradesh received an advance installment of ₹31,962 crore, while all five Southern states combined received only ₹28,152 crore.
Karnataka Chief Minister Siddaramaiah articulated the regional frustration, stating, "States with higher GSDP per capita, like Karnataka and others, are being penalised for their economic performance... This unjust approach undermines the spirit of cooperative federalism and threatens the financial autonomy of progressive states."
The friction extends beyond tax devolution into the realm of policy compliance. In October 2025, Kerala froze its implementation of the PM SHRI education scheme. Credible reports indicate the state had initially signed a Memorandum of Understanding (MoU) to join the scheme primarily to access central funds under the Samagra Shiksha scheme—funds that had been withheld by the Centre to force compliance.
Similarly, in January 2026, Jharkhand ministers petitioned the Union government, alleging that ₹2,736 crore recommended by the 15th Finance Commission and ₹2,100 crore in urban development funds had been withheld due to delayed municipal polls.
The Union's Defense: A Crisis of Fiscal Indiscipline?
While state leaders point the finger at New Delhi, the Union government and its representatives argue that states are using the federal structure as a scapegoat for their own populist spending and fiscal indiscipline.
Former Union Minister and BJP MP Anurag Thakur directly countered the Himachal Pradesh Chief Minister's claims, stating: "RDG was never meant to be permanent. Himachal ignored repeated fiscal warnings and is now blaming the Centre to hide its own mismanagement."
The Centre's defense is rooted in hard data regarding state-level revenue generation. Thakur highlighted that Himachal Pradesh suffers from chronically low own-tax revenue, hovering around just 5.6% of its GSDP, coupled with unsustainably high revenue expenditure. Furthermore, official records show that the state has received over ₹40,000 crore in tax devolution and grants since 2023.
Mainstream media coverage frequently echoes this perspective, reducing these budget crises to partisan squabbling over "freebies" or poor state-level debt management. It is undeniable that state-level fiscal indiscipline—such as the heavy financial burden of reverting to the Old Pension Scheme or providing heavily subsidized utilities—plays a significant role in draining state coffers.
The Missing Narrative: Cesses, Surcharges, and Conditionalities
However, framing the crisis solely around state-level populism misses the systemic shift in India's political economy. The contradiction lies in the Centre's dual approach to federalism.
Officially, the Union champions "cooperative federalism" and points to the 14th and 15th Finance Commissions' mandates to devolve 41% to 42% of central taxes to states. In practice, the Centre increasingly utilizes cesses and surcharges to raise revenue. Crucially, revenue collected via cesses and surcharges is kept entirely by the Union and is not shared with the states. By shrinking the divisible pool of taxes, the Centre effectively bypasses the Finance Commission's devolution mandate.
Simultaneously, the Centre leverages Article 282 to route an increasing share of funds through Centrally Sponsored Schemes. By attaching strict policy adoption conditionalities to these funds—such as withholding education grants from Kerala and Tamil Nadu until they adopt the National Education Policy-linked PM SHRI scheme—the Centre effectively weaponizes fiscal transfers to enforce centralized policy mandates on state subjects.
For a state like Himachal Pradesh, which has limited avenues for internal revenue generation due to its mountainous geography and ecological constraints, the sudden tapering of deficit grants and the lowering of borrowing limits act as a fiscal chokehold. The state is left with a binary choice: surrender policy autonomy to access central funds, or face financial ruin.
Conclusion: A Constitutional Stress Test
The Himachal Pradesh budget crisis is not merely an accounting failure or a localized political dispute; it is a constitutional stress test for the Republic of India.
When the mechanisms of fiscal federalism—designed by the framers of the Constitution to be neutral, objective, and formulaic under Article 280—are overshadowed by discretionary grants and political conditionalities, the autonomy of states is severely compromised. The data from Himachal Pradesh, Karnataka, Kerala, and Jharkhand collectively point to a systemic centralization of fiscal power.
State governments must undoubtedly take responsibility for their own fiscal discipline, expanding their internal tax bases and curbing unsustainable populist expenditure. However, fiscal discipline cannot be enforced through the arbitrary strangulation of state finances by the Union.
Until the balance between central policy goals and state financial independence is restored, and until the loopholes of cesses, surcharges, and Article 282 are addressed, "cooperative federalism" will remain a constitutional ideal rather than an economic reality. The ledger of India's democracy requires both sides to balance, and currently, the scales are tipping dangerously in one direction.