According to the Reserve Bank of India study on State finances, the maximum capital spending is allocated towards rural development. This means that a significant amount of money is being invested in improving the infrastructure, facilities, and services in rural areas.

Option 1: Rural development - This option aligns with the correct answer provided. It indicates that capital spending is focused on improving the development and well-being of rural areas.

Option 2: Water supply and sanitation - Although important, this option does not necessarily encompass overall capital spending. While water supply and sanitation may be a part of rural development projects, it is not the sole focus.

Option 3: Urban development - This option is not in line with the correct answer. The study states that capital spending is maximum in rural development, not urban development.

Option 4: Education - This option does not align with the correct answer. While education is undoubtedly an important sector, the study specifically highlights rural development as the area with the highest capital spending.

In conclusion, the correct answer is option 1, rural development.