Basic public finance

The government levies taxes (demands money at the point of a gun) to finance expenditure (i.e. pay for things).

The budget is a plan for how much money the government will raise and how much it plans to spend in a particular year. The government says “we will put taxes on these people” and “we will put taxes on these transactions” and guesses how much money that will bring in. And the government says, “we will hire these many police officers” and “we will defend this border” and “we will give every household six LPG cylinders” and guesses how much money that will cost.

The deficit is the difference between what the government plans to spend and the total amount it plans to raise. In other words, the fiscal deficit is how much the government plans to borrow that year, because it has spending that it cannot finance through taxes and other sources of revenue.

The debt is the accumulated borrowings. If the government borrows ₹5 every year for ten years, the fiscal deficit is ₹5 every year, and the debt at the end of those ten years is ₹50.

Debt is not necessarily bad. An elementary notion in finance is that one thinks about the cost of capital in relation to the expected return on your investment. You want to borrow for less than you eventually hope to make back. Borrowing is not inherently bad. This is plainly intuitive if you understand the idea of a business loan.

You need comparators. Now, the absolute number of ₹50 is not very useful, because it is a very different thing for me to have ₹1 lakh in debt and for Mukesh Ambani to have ₹1 lakh in debt. Our ability to repay depends on how much money we make. And so it makes no sense to represent our relative indebtedness by saying we both owe ₹1 lakh. We solve this by representing the number as a fraction of something else. We add a denominator.

In this way, we can compare the situation in various states and countries.

The GSDP is a useful denominator. The Gross State Domestic Product (GSDP) of Tamil Nadu is an estimate of the value of things made and services provided in Tamil Nadu during a given financial year and so we can express the debt as a percentage of the GSDP. This gives us a better picture of the fiscal position.

Tax revenue is another useful denominator when you want to understand repayment pressure. If you want to understand how burdened a government is by its borrowings, divide the debt by its tax revenue instead. A government that owes ten times its annual tax collection is in a very different position from one that owes three times its annual tax collection, even if their debt-to-GDP ratios look similar.

The thing I am trying to get across here is that these ideas are remarkably simple. You really can, and should, be thinking about how well your government is doing at fiscal management.

Imposing political costs for fiscal lies

Misleading people about the fiscal situation is one of the principal goals of political communication. The new Chief Minister of Tamil Nadu, moments after taking the oath of office, has begun complaining about the state's fiscal situation.

The Government has borrowed more than ₹10 lakh crores and has completely emptied, wiped out, scraped the treasury clean. They have left a burden to us that is impossible to carry. It is in this sort of situation that we have taken up this responsibility. You may immediately think, "This person is talking nonsense." There is nothing like that. Only if you go inside and check will you be able to tell: what is there, what is not there, what is in what condition, what is not in what condition." [The crowd cheers] So, I'll go look at all of that and give you a white paper."

In the same speech, he asked for patience from the electorate as he tries to implement his manifesto promises, which include enormous spending commitments that will increase the deficit. The Chief Minister has also authorised, on his first day, additional spending which will be difficult to reverse, such as free electricity up to 200 units. It is unserious to sanction subsidies and say you don't know the condition of the public finances on the same day.

The Chief Minister is making an almost cliched political move.

In 2024, the UK Labour party made this move, when they came to power by promising not to raise taxes. Once they came to power, they jettisoned this manifesto commitment by claiming that the Conservatives had left a £22bn black hole in the budget. This was an attempt at misleading the public about the fiscal position (which the Conservatives had also been guilty of).

In mature constitutional democracies such as the United Kingdom, there are also strong institutions, such as Office of Budget Responsibility (OBR) and strong civil society institutions like the Institute for Fiscal Studies (IFS) who lead the public conversation on issues of taxation and government spending, carefully analyse the situation, and speak fiercely and independently in defence of the public finances. This means that governments are held to account, and pay a greater political cost for unseriousness.

We need such institutions and organisations in India, for every state and every major city in India. We do not have such institutions, which impose political costs on people who make misleading statements. It's worth thinking about how to start building them.

Further reading

Ajay Shah, Be you ever so high, the markets are always above you (The Leap Blog, 10 April 2025)