However, the official response to the crisis has one serious shortcoming. It does not take into account the important role that the states can play in reversing the downturn.
The downturn has already started taking its toll on states tax receipts. As a result, some states could be forced to raise tax rates or to cut down on the planned expenditure. Any such move will surely dilute the efficacy of the central fiscal and monetary policies, if not neutralise them altogether. Moreover, the execution of the fiscal stimulus package needs the cooperation of the states. A lackluster response by them can thwart the centers plans of additional spending on social and infra-projects.
The fiscal position of several states has now started deteriorating. During the last two fiscals, however, states experienced impressive growth in tax revenue. As a result, several states were able to reduce traditionally large revenue and fiscal deficits. So much so that in 2007-08 states exhibited an aggregate revenue surplus of Rs 225 billion. This success is due to an unprecedented growth in collections from VAT, state excise and stamp duties. Unfortunately, the current meltdown has already reversed this trend. Growth of VAT collections is down to 19.9 % from an impressive 24% in the first two quarters of this fiscal. Consequently, the states aggregate tax collection rate has come down drastically to 12% in November, compared to 23% in October this year. On top of it, recent tax concessions granted by the center have reduced the size of the divisible pool of central taxes. The states have 30.5 % stake in it.
Even economically better off states such as Andhra Pradesh, Maharashtra and Punjab have projected large revenue deficits for this fiscal. In this scenario, states governments are genuinely worried. The empowered committee of state finance ministers in its wish list has demanded grants of Rs 20,000 crore, to enable the states tide over the crisis.
Otherwise also the execution of a stimulus package needs assistance of state governments. The last package has earmarked additional Rs 20,000 crore for rural infrastructure and social welfare schemes, over and above the budgetary provisions. Some of these schemes like National Rural Employment Guarantee Act and Mid-day meal require financial contribution by the states as well.
In order to ensure the success of fiscal package the center should get the states on board. State governments should be provided with incentives to expand rather than reduce the rural and infrastructural investment. They should be encouraged to expedite the implementation of these and projects sponsored by the center such as highway projects. Centrally sponsored infra-projects necessitate the support of state governments in land acquisition, shifting of utility, etc.
In order to achieve these objectives, the next stimulus package should pay heed to the genuine concerns of the states. The following three measures can help. First, market borrowing by the states should be allowed in excess of their existing quota. Second, states should be granted temporary exemption from the requirements of the fiscal responsibility and budget management (FRBM) Act. Third, grants can be provided to needy states for investing in rural infrastructure. The first two measures will help ease up the financial crunch faced by the states. The third measure can be used to demand better implementation of centrally sponsored welfare schemes such as NREGA, Pradhan Mantri Gram Sadak Yojna (PMGSY), and to expedite infra-projects. Eligibility for grants can be made conditional on the performance of the states on these fronts.
The author teaches at Delhi School of Economics. Email: firstname.lastname@example.org