Contingency plan: Building Tamil Nadu’s fiscal shock absorber

When state revenues swing unpredictably, the damage goes far beyond balance-sheet arithmetic. The real consequences are felt in crumbling roads, overcrowded classrooms, and understaffed primary health centres. Tamil Nadu possesses genuine fiscal strengths, including a diversified economy, sizable own-tax receipts, and substantial social infrastructure. Yet an under-appreciated structural vulnerability threatens this foundation: the state’s growing exposure to volatile central transfers, the uncertainty of its own tax collections during economic shocks, and the disappearance of the GST compensation safety net. Without a clear contingency framework, the next revenue shock will inevitably force disruptive trade-offs, with ordinary public services suffering first.

The fiscal cushion that supported states after the 2017 rollout of the Goods and Services Tax (GST) has now largely vanished. The five-year compensation mechanism, designed to protect states from revenue shortfalls during the new tax regime’s transition, ended in mid-2022. While this expiry was anticipated, its passing tightens the fiscal screws. States must now manage revenue volatility without that temporary buffer. For Tamil Nadu, this is particularly consequential; nearly half its revenue receipts now come from the Centre as devolution, grants, and other transfers. These flows, though substantial, are not always predictable in their timing or final composition. Past delays or unexpected shortfalls have already forced the state to borrow simply to meet routine spending obligations.

The performance of the state’s own taxes offers little reassurance. Tamil Nadu’s own-tax portfolio includes economically sensitive items like stamp duties, motor vehicle taxes, excise, and certain commercial levies. The pandemic caused sharp contractions across these revenue lines. Although collections later rebounded, the threat of episodic downturns remains very real. Furthermore, external shocks — a global demand slowdown, a severe cyclone, or a commodity price spike — can simultaneously depress collections and inflate expenditure, creating the ‘double whammy’ familiar to budget analysts.

Conventional policy responses — ad hoc borrowing, deferring capital projects, or redirecting investment funds to cover routine expenses — offer short-term relief at a high long-term cost. Rising debt ratios shrink future fiscal space and crowd out the capital expenditure vital for long-term growth. Tamil Nadu’s public debt as a share of GSDP has been creeping upward in recent years. Without proper buffers and improved planning, future downturns will inevitably squeeze the state’s capacity to fund essential services and infrastructure.

Three pragmatic, apolitical steps could significantly bolster the state’s fiscal resilience. First, the government should adopt conservative, evidence-based revenue forecasting. Over-optimistic projections of own-tax growth are a recurring issue. Fiscal planning must shift from single-point projections to methods using rolling averages and scenario analyses. A practical approach would calibrate baseline estimates using a five-year moving average, adjusted for identifiable cyclical risks, and publish alternate ‘stress’ scenarios in budget documents. More realistic forecasting reduces the need for disruptive mid-year corrections and builds credibility with investors and rating agencies.

Second, it is crucial to create a Revenue Stabilisation Fund governed by clear, operational rules. Many well-run jurisdictions maintain rainy-day funds, which are capitalised during surplus years and drawn upon during shortfalls. For Tamil Nadu, the fund need not be large initially; a target equal to a modest share of one year’s own-tax volatility would suffice. Its effectiveness, however, depends on transparent governance: defined triggers for withdrawals, strict limits on use (for revenue smoothing, not new recurring commitments), and public reporting of all balances and flows. The 15th Finance Commission itself recommended state fiscal buffers; establishing a disciplined fund would put this advice into practice, creating an explicit safety valve for future shocks.

Third, the state must publish a formal fiscal contingency plan that prioritises core public services. Not all spending is equally flexible. Cuts to primary healthcare, basic education, and essential infrastructure maintenance inflict far greater social costs than temporary pauses in discretionary programs. A credible contingency plan would clearly identify protected expenditure lines, list potential areas for discretionary adjustment, and spell out automatic stabilisers, such as a temporary suspension of non-essential recruitment or a phased deferment of non-critical capital projects. Publishing such a plan before a crisis strikes has a dual virtue: it reduces uncertainty by signalling government priorities and disciplines political debate by establishing objective criteria for future adjustments.

These three instruments are mutually reinforcing. Conservative forecasting minimises surprises; a stabilisation fund provides a cushion when shocks occur; and an explicit contingency plan ensures that any necessary adjustments protect the most vital services. Implementation is entirely feasible. A fund could be seeded from revenue surpluses or one-off receipts; the budget office can be mandated to publish stress scenarios alongside annual estimates; and existing budget rules can be amended to formally stipulate protected spending lines.

This approach does not imply a default stance of austerity. On the contrary, it represents prudent financial management — a recognition that volatility is a permanent feature of 21st-century public finance. Climate events, global supply disruptions, and economic cycles will continue to test state treasuries. Planning now for how to manage these shocks is a direct investment in predictability and social protection.

If Tamil Nadu aims to preserve its hard-won development momentum, a modest shift in budget design will yield substantial dividends. Fiscal resilience is not a mere accounting abstraction; it is the practical mechanism that ensures essential services remain stable during tough times. Revenue volatility is not an anomaly to be endured. With sensible rules and straightforward instruments, it can be managed effectively.

Thakur is Professor and Dean at Vinayaka Mission’s School of Economics and Public Policy, Chennai