Column: Budgeting for fiscal consolidation

A reform of the budgetary process with better forecasting and a transition towards accrual accounting is needed

The finance minister will be presenting the first full budget of the present government and there are naturally a lot of expectations from industry, trade and the common man alike. The finance minister has had sufficient time to take stock of things and there is a competent team of officials in place to bring in a fresh approach. While it is true that the state governments have equally important if not larger roles in reviving the economy, the Union budget is seen as an important signalling instrument. The finance minister too has, in many a fora, indicated that the reform agenda will be taken forward in the budget.

The budget for FY16 is formulated in a much more favourable environment than that existed in the last six years. Although global recovery has been slow and uncertain, domestic factors have turned around for the better. The economy has bottomed out and the growth rate is expected to be much higher than the last year’s. The low international oil price has helped to contain subsidies, the current account deficit as well as the inflation rate. The last factor should provide sufficient room to begin the virtuous cycle of rate-cuts, which has already begun with Reserve Bank of India reducing the repo rate by 25 basis points on January 15. On the governance front there is much better coordination among the infrastructure and environment ministries and that should help to ensure faster clearances.

This is not to underestimate the formidable challenges faced in achieving fiscal consolidation and reviving the economy. Adhering to the deficit targets set in the medium-term fiscal plan (MTFP), arresting the declining ratio of tax-to-GDP, containing proliferating expenditures on subsidies and transfers and enhancing capital expenditures to revive infrastructure investments—all these present a challenging task. Reviving the investment climate, dealing with accumulated problems of stalled projects and its spillover on the banking system and transforming the weak institutions are formidable enough.

The most important task of the finance minister is to restore credibility in the budget. The Mid-Year Review has candidly admitted to its opaqueness. The review brings out two important issues of concern which needs to be addressed to restore people’s faith in the budget. First, the quality of forecasts is poor, or the budget estimates are more in the nature of wishful thinking. The overestimation in revenues was almost 0.8% of GDP which is due not merely to unrealistic assumption on growth and inflation, but also assumption on higher than observed tax buoyancy. Second, the lack of transparency is so ingrained in the budgetary process that the government itself does not seem to know the real fiscal deficit number. The estimated expenditure spill over on account of carry-over of subsidies as a ratio of GDP ranged from 0.3-1%, and this is a clear admission of the fact that the finance ministry itself does not even know the extent of expenditure underestimation. Year after year, in attempting to show adherence to the MTFP targets, the subsidy bill is carried over, more so in the years of greater fiscal stress and the government does not have a realistic estimate of this. Unfortunately, these shortcomings are by design and not by default. It is time that the government started serious reform of budgetary process including having a better forecasting, information system and transition towards accrual accounting.

The most important issue keenly watched will be the government’s approach to fiscal consolidation. The Mid-Year Review discusses the poor investment climate due to stalled projects amounting to over 13% of GDP and its spillover into the banking sector, bad experience of PPP, and weak institutions and high implementation risks. Based on the premise that the public sector is in a better position to face the implementation risks, the review argues for a “counter-structural” position in which public sector investment should be increased substantially even if it has to be financed by higher deficits. The ambivalent stand on fiscal deficits is definitely a matter of concern.

On the revenue side, the most important measure that should be undertaken is to rationalise the Union excise duties and the service tax. This is an opportunity to show leadership in implementing GST. In fact, the recommendation to move towards GST was first made in the Report of the Expert Group on Taxation of Services (of which I was the Chairman) in 2001 when the NDA government was ruling. The recommendation was simply to tax all services with a small negative list, rationalise excise duty structure to minimise exemption, convert all the rates into ad valorem, unify the excise duty with the service tax rate and extend input tax credit mechanism for both goods and services to evolve a goods and service tax at the manufacturing stage. This does not require Constitutional amendment. Rather than unifying the rates, the succeeding governments continued to vary the rates to satisfy various interest groups and provided concessions for one reason or another. There is no rationale for continuing with so many exemptions, taxing items like cement at specific rather than ad valorem rates and levying lower tax rates for breakfast cereals and packed juices. The objective of tax policy is to raise revenue for development. It is time that the government stops loading the tax policy with so many objectives besides revenue and equity such as regional development, promotion of small scale industry, enclave development, promotion of small cars and incentive for certain types of vehicles and infrastructure development. In the case of service taxation, it is time to prune the exemption and negative lists to broaden the base. All services must be taxed including railways, newspaper advertisement and legal services.

On the expenditure side, the government already has a number of reports. While lower oil prices will help to contain the subsidy bill on oil and to some extent fertilisers, restricting transfers for rights based schemes will continue to pose challenges. Revision of administered prices of urea, and closing down of non-priority public enterprises with significant opportunity costs should not be difficult. Allowing the spending departments flexibility in purchasing their air tickets and doing away with the transactions through the government-owned agency can save at least 15-20% of travel cost that the government incurs. The most important savings will have to come from doing away with most of the centrally-sponsored schemes. It is necessary to have specific purpose transfers to states, but only in the case of services which are considered to be national importance for reasons of externality, merit goods and redistribution and such schemes cannot be more than 10.

Indeed, the budget in this country is much more than mere tax and expenditure measures. Nevertheless, the fiscal stance of the government will be keenly watched for its reform signals besides providing clarity on the availability of credit, the rate of interest and overall economic environment.

By M Govinda Rao
The author is a former member, Fourteenth Finance Commission, and presently, Emeritus Professor, NIPFP Comments at

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