New Delhi , Aug. 31: The pay increase announced by the central government for its 3-million-strong workforce could set off a chain reaction among state governments and municipalities, though some of them can hardly afford a hike.

Officials said the states, who employ around 7 million employees, could end up spending up to Rs 25,000 crore annually on a hike and Rs 40,000 crore in past arrears.

Since 1997, when they implemented a hike and slipped into the red, states have considerably improved their finances and have a combined surplus of Rs 11,973 crore.

In 1997-98, only nine of 26 states had a revenue surplus, with their combined revenue accounts showing a deficit of Rs 16,333 crore. However, by 2007-08, only nine out of the expanded list of 30 states have revenue deficits.

Analysts said improved VAT (value added tax) collection and strong tax buoyancy would help states in managing the negative impact of the pay revision.

Gross tax collection in the first quarter of 2008-09 (April-June) increased 28.4 per cent, though growth in this period fell to 7.9 per cent.

Fear factor

North Block officials estimate the cost of the pay hike this time could see some states slipping into the red, as was the case in 1997.

West Bengal and Kerala, which had budgeted revenue deficits of Rs 7,168 crore and Rs 5,251, respectively, in 1997-98, could be among the worst hit, if they raised salaries in line with the central government.

Even states which have been posting revenue surpluses could slip into the red.

Haryana, which has already announced a hike, would need about Rs 1,500-2,000 crore to implement the move. Harayana’s revenue surplus is Rs 1,149 crore, which may get wiped out once it starts paying salaries.

“The problem for most states is that their revenue earnings are still not high enough to withstand a sudden expenditure shock. Introduction of VAT has meant that state revenues are buoyant, but it takes time to nurse financially sick states back into good health. One cannot expose them to high expenditure levels so soon,” said S.P. Gupta, former member of the Planning Commission.

The only way to accept higher wage payments and, still, remain afloat is to rationalise workforce with golden handshakes.

This will be politically difficult, besides involving one-time costs of a voluntary separation package.

Though most states have set up panels to study and adopt the central government pay hikes, few are likely to agree to any drastic reform measure.

Since there are elections coming up in many states soon, it will be politically difficult to undertake any necessary but unpopular reforms.