The Relationship Between Government Revenue, Government Expenditure and Economic Growth in India: An Empirical Investigation at the Sub-national Level

This paper examines the relationship between government revenue, expenditure, and economic growth for Indian States in a panel framework while also identifying the drivers of States’ primary expenditure. On the one hand, the study confirms a long run relationship between revenue and expenditure thereby supporting ‘fiscal synchronization’ hypothesis whereas on the other, the existence of a long run association between expenditure and economic growth is detected providing support to the ‘Wagner's law’. Given the importance of primary expenditure in the overall expenditure, the study finds that the States’ primary expenditure has a persistent effect, with past decisions on primary expenditure influencing current-year decisions. States pursue countercyclical expenditure policy in case of positive and negative output gaps, with more pronounced countercyclicality during negative output gap periods. Regarding the States’ sensitivity to their debt levels, the study finds States responding to the level of debt countercyclically in case of positive output gap. The study recommends increasing capital expenditure and debt reduction during phases of positive output gaps to ensure long-term fiscal sustainability of Indian States.