Welfare Expenditure and Fiscal Federalism in India

GS PAPER III — Economy | GS PAPER II — Governance & Fiscal Federalism

Why in News? The Constitution’s Preamble envisions India as a ‘Socialist’ and ‘Welfare State’, with Articles 38, 39, 41, and 47 under the Directive Principles directing the State toward social security, health, and education. Recent budget data, however, shows this constitutional promise is being funded overwhelmingly by the States rather than the Centre — reopening a long-running fiscal federalism debate.

Who Collects the Money vs Who Spends It

A structural mismatch runs through India’s welfare architecture: the Central Government collects the bulk of national tax revenue, but the primary responsibility — and financial burden — of actually implementing welfare schemes at the grassroots falls on the States.

For 2025-26, the combined allocation for selected welfare schemes stands at ₹24.20 lakh crore, or 6.77 percent of GDP. Of this, the Centre’s own contribution is just 1.89 percent of GDP — meaning the much larger remaining share is being financed by State budgets.

This isn’t a one-year anomaly either. While total real spending on social services has risen over time, the Centre’s share within that spending has stayed nearly flat, meaning nearly all of the increase in India’s social security spending has landed on State finances.

From Legal Entitlements to Cash Transfers

The 2000s saw India build an entitlement-based welfare model, giving legal backing to promises around food, education, and employment through laws like MGNREGA and the Right to Education Act — a shift that turned citizens from supplicants into rights-holders.

Over the past decade, policy has drifted toward Direct Benefit Transfers instead. States alone now spend ₹4.14 lakh crore on unconditional cash transfers, marking a meaningful shift away from the earlier legal-entitlement approach.

How Centrally Sponsored Schemes Deepen the Burden

Major Centrally Sponsored Schemes have traditionally split costs 60:40 between Centre and States (90:10 for Northeastern states). But newer laws — such as the VB-GRAM G Act replacing MGNREGA — are set to push even more of the financial burden onto States.

States already carry the lion’s share of school education spending, contributing 75.2 percent of the national total, and are similarly dominant funders in the health sector.

Why This Matters for Long-Term Growth

Research by Ghose and Banerjee in the Economic and Political Weekly points to a mutually reinforcing cycle between human development and economic growth — investment in education and health raises productivity, which in turn strengthens GDP.

Yet despite a tax-to-GDP ratio broadly comparable to other middle-income countries, India spends far less on social security as a share of GDP than most global peers — suggesting the constraint is political and structural rather than purely fiscal capacity.

How Major Welfare Schemes Split Costs Between Centre and States

Scheme	Cost-Sharing Pattern
ICDS & PM Matru Vandana Yojana	60% Centre : 40% States
Samagra Shiksha Abhiyan (School Education)	States bear ~75.2% of total spending
MGNREGA (traditional structure)	90% Centre : 10% States
State-funded unconditional cash transfers	₹4.14 lakh crore borne entirely by States

Way Forward

The 16th Finance Commission should explicitly factor in States’ social sector commitments and fiscal burden while deciding vertical devolution of taxes.
The Centre should raise its own budgetary commitment to social security beyond the current 1.89% of GDP to give real weight to constitutional Directive Principles.
Grants to States should be linked to social outcome indicators — health, education, and nutrition improvements — to ensure spending efficiency.
Policy should rebalance away from pure cash transfers toward long-term capacity building such as quality education and universal healthcare, reviving elements of the entitlement-based model.

India’s welfare architecture today asks States to carry a disproportionate share of a constitutionally mandated national commitment. Correcting this imbalance — through smarter devolution, higher central commitment, and outcome-linked grants — will be central to making India’s welfare state genuinely sustainable.

UPSC Note — GS Linkage & Exam Angle This is a high-value GS II/III crossover — fiscal federalism, Centre-State financial relations, and the Directive Principles all converge here. The 1.89% vs 6.77% GDP figures are precise, examiner-friendly numbers worth memorising for any question on social sector financing.

Mains Practice Question “Tax revenue financially benefits the Central Government, but the burden of funding public welfare schemes falls disproportionately on the States.” Critically analyze this statement in the context of current trends in fiscal federalism in India. (250 words, 15 marks)

Prelims MCQ Practice With reference to welfare expenditure in India, consider the following statements: 1. For 2025-26, the Centre’s own contribution to combined welfare scheme allocation stood at about 1.89% of GDP. 2. States currently bear about 75.2% of total national expenditure on school education. 3. The cost-sharing ratio for Centrally Sponsored Schemes in the Northeast is generally 60:40 between the Centre and States. Which of the statements given above is/are correct? (a) 1 and 2 only (b) 2 and 3 only (c) 1 and 3 only (d) 1, 2 and 3 Answer: (a) Statements 1 and 2 are correct. Statement 3 is incorrect — the Northeast typically follows a 90:10 Centre-State cost-sharing ratio, not 60:40.