Can be destabilising for the state governments

Written by KN Harilal | Updated: Jul 1 2008, 04:53am hrs
Any move that adds to the fiscal imbalance, either by way of adding to the expenditure commitments of the states or by reducing their revenue receipts should therefore be eschewed.

In my view to ask the states to bear the costs of the cut in taxes on oil products will be grossly unfair for a number of reasons. The first and the most important reason is the fiscal vulnerability of the state governments. Given the constitutional responsibility of the states in the spheres of developmental as well as welfare expenditure (for instance irrigation, roads, power, education, health etc), not to speak of their administrative responsibilities in areas such as law and order and general administration, it is extremely difficult for them to effect any major cuts in expenditure. The combined expenditures of states as a percentage of GDP increased from around 4.75% in 1950-51 to around 16% in 2006-07. The aggregate state government expenditure is almost inflexible downward. But, as past trends suggest expenditure of the centre, the ratio of which to GDP declined from 17% during early 1990s to 14.5% in 2006-07, have been much more flexible. While the states are over burdened with expenditure responsibilities revenue raising powers have remained concentrated in the hands of the centre. According to estimates for 2005-06 while all states taken together got 38% of the total revenue collected in the country 62% went to the central government. Further, the share of net central transfers to the states has also been declining over time. In short, the vertical fiscal imbalance in the federal system, which arises on account of the mismatch between expenditure responsibilities and the revenue raising powers, has been worsening systematically over a long period of time. Any move that adds to the fiscal imbalance, either by way of adding to the expenditure commitments of the states or by reducing their revenue receipts should therefore be eschewed. Unfortunately, the development in the oil front appears to combine both these adverse aspects. The rise in oil prices is sure to raise expenditure of state governments. As such any reduction in the revenue receipts on account of cut in taxes on oil products can be highly destabilising the states.

The vertical imbalance in the fiscal system suggests that the burden of the oil shock is best borne by the centre for it enjoys wider revenue raising powers. Take for instance the case of tax on services. They have emerged as one of the most buoyant sources benefiting the centre. To cite examples more proximate to the oil economy, if the centre has the political will it can very well take over a part of the windfall gain of oil companies. Further, it is interesting to note that the centre has been the main beneficiary of the high incidence of taxes on oil products. Taxes on oil products accounted for as much as 52% of the final prices. Numbers for the year 2007-08 show that the share of the central taxes from oil was as high as 61.9% whereas the states share was only 38%. It is only fair that the centre continues to bear the full impact of the tax cuts on oil products till the benefits from oil taxes are at least equalised.

On the expenditure side also the centre is a better candidate for absorbing any reduction on account of the rise in oil prices or cuts in taxes. The total expenditure of the central government was only 13.8% of the GDP as per the budget estimates for 2007-08 as against 17% for the state governments. There are also issues like the quality of spending of the centre and the states and its implication on growth. The development expenditure incurred by the centre was only about 7.5% of the GDP in 2007-08, while it was a third more for the states.

All these only serve to prove that the implications of the tax cuts on oil products would not only be much more on the states but will also impact the overall growth and development much more severely if the states are asked to pay for them. So it is only fair that center bears the full costs of the tax cuts on oil products whatever be the equity norms that one would choose to consider.

The writer is a member of the Kerala State Planning Board