Demographic gaps: Why different states need different budget allocations as they age

First, the good news. The fiscal health of state governments is improving. True, their consolidated gross fiscal deficit rose to 3.3% of India’s GDP in 2024-25, after staying below 3% during the previous three years. But this increase is mainly due to 50-year interest-free loans from the Centre under its special assistance scheme for capital investment.

At the same time, the total outstanding liabilities of states declined from a peak of 31% of GDP at the end of 2020-21 to 28.1% at the end of 2023-24.

The theme of this year’s study, ‘Demographic Transition in India—Implications for State Finances,’ points out that Indian states are at different stages of a demographic transition. Inevitably, this has consequences for their finances and policies.

Their old-age dependency ratio, or the elderly count as a proportion of their working-age population, varies from 14% in Bihar to 30% in Kerala. Fiscal deficits as a proportion of gross state domestic product (GSDP) also vary widely—from Arunachal’s little over 8% to Gujarat’s little less than 3%. This variation necessitates differential fiscal policy approaches, as suited to their respective age structures. It also poses entirely different fiscal challenges.

Youthful states have a wider window of opportunity, thanks to an expanding working-age population and stronger revenue mobilization—but only if they adopt a favourable policy environment, one that emphasizes quality education, skill training, healthcare facilities and job opportunities.

In contrast, ageing states face a narrowing window—with fiscal pressures arising from shrinking tax bases and rising committed expenditure; this calls for greater revenue-raising capacity and reforms in healthcare, pension and workforce policies.

What the study does not talk about is the fallout of this divergence in demographic profiles on internal migration and the resultant social tensions between locals and migrants from populous states in search of jobs. Understandably, it is also silent on another aspect of differing demographic paths: its implications for political representation after the 2027 Census is done.

The study’s focus on the demography of Indian states in the context of their finances is important for another reason. It provides the context for a clear-headed analysis of recommendations of the 16th Finance Commission (FC) once they are made public.

Under the Constitution’s Seventh Schedule, the sharing of expenditure responsibilities between the Union and state governments is clearly laid out in its Union and State lists. On the revenue side, however, it is the awards of FCs—made every half decade—that determine how revenues are split between the Union and states.

So far, ‘population’ has been used by all FCs as one of the criteria for the sharing pattern among states. This will probably find place in the 16th FC’s report as well; its rationale is that a state’s population has a direct bearing on the money it must spend on economic, social and general services. But this has often been a source of tension between states that are further down in their demographic transition and those that are not.

Hopefully, our need for differential policies to deal with varying trajectories, as the RBI study finds, will result in a better-informed debate on what the 16th FC recommends.