Abstract Differences in revenue and expenditure responsibilities among Indian states are determined by variations in fiscal prudence, fiscal space and political economy, leading to challenges for economic development as states require additional funding to meet their responsibilities. We use spatial econometric methods to analyse the influence of neighbouring states’ social sector expenditure (SSE) and fiscal indicators patterns, including political economy and their interactive pattern on neighbouring states’ expenditures for 21 states from 2010 to 2023. The empirical investigation shows a significant amount of geographical interaction and yardstick rivalry, in which governments adjust spending according to the spending of their neighbours. The states compete to match or exceed the spending levels of their neighbouring states, which has a significant role in influencing decisions about SSE. This highlights the implication of state governments not acting in fiscal isolation. Instead, social sector spending decisions result from internal financial and political conditions and external influences from neighbouring governments. This relationship has implications for intergovernmental fiscal transfers, stressing approaches that can effectively address horizontal fiscal imbalances. However, the findings highlight the need for appropriate fiscal prudence in resolving vertical and horizontal inequities within federal institutions. These results imply that competitive constraints can optimise resource allocation in the social sector to yield higher welfare outcomes and promote social well-being. These results validate the instrumental role of central grants in reducing regional disparities in human development at the subnational government.
Kumar et al. (Fri,) studied this question.