Fiscal murmurs

Economic downturns are cruel. They impose traumatic disruptions in incomes and lives – salary cuts, extended long leave without pay, outright job loss, drying up of business income or bankruptcy. 

The cash crunch for government is at crisis levels

The government is no different. Revenue receipt of the Union government in May (Rs 0.17 trillion) was 36% lower than in April (Rs 0.27 trillion). 

The good news is that not all of that is because of the Covid shut down. Revenues in the month of May tend to be one half to 20% lower than April. The bad news is that this year the April revenue itself was just 29% of last year and 39% of the same month, year before.

April and May were peak “shut-down” periods so the revenue loss is not unexpected. June the last month of Q1 saw some relaxations in inter-state and within state movement, especially for goods. Sadly, metro cities, which are the main revenue earners, remain mired in the Covid disruptions. Nevertheless, revenue should trend up to around Rs 700 billion in June reflecting the “half- working” state of the economy. 

Q1 revenue would then be Rs 1.15 trillion – around 40% of last years. GDP data comes with a lag. But a fall in GDP in Q1 versus the previous year of around 25% is generally expected. 

Derisk public finance

Consider however India’s peculiar problem. A 25% decrease in Q1 GDP results in a 60% decrease in government revenues. An end of year decline of 10% in GDP could translate into an annual revenue loss of 20% of last year’s revenue receipts of Rs 20 trillion, or Rs 4 trillion. This amounts to 2.2 % of GDP. 

The budgeted fiscal deficit (Rs 8 trillion) was 3.5% of GDP when GDP was assumed to be RS 204 trillion this year. On the new reduced GDP level of 184 trillion (10% lower than last year) the existing nominal FD is 4.3 %. Add to that budgeted but permanently lost revenue of Rs 4 trillion and you end up with an FD of 6.5% of GDP this year. State governments have been permitted to increase their FD levels from 2% to 4% of GDP. The Union will need a special relaxation above the allowable 4% of GDP.

The Union’s debt funding requirement would increase from around Rs 8 trillion earlier to Rs 11.7 trillion. This factoid reflects our low resilience to economic disruption – primarily because of our narrow tax base focusing on industry, business and the salaried class but with nominal tax on the use of natural resources like land and water.

Diversify the tax base

India is resource-constrained in both these natural resources, This makes it both economically and environmentally sensible to tax their extraction and use. Of course, the Union government will not benefit from these taxes which will accrue to the state governments. 

A more nuanced strategy to conserve water is being piloted in Punjab where grid-connected solar power systems energize pumps for groundwater extraction but retain the incentive to conserve on water use by providing the option to the farmer to sell spare electricity to the grid. Implementation issues exist but the strategy is progressive (

A national fiscal council

But then again, isn’t it about time we thought of a high level, permanent National Fiscal Council which could subsume the GST Council; optimize the tax structure on a national basis and determine the vertical division of taxes between the Union and the States and horizontally across the States. This task is currently done by a Finance Commission set up every five years – the 15th under chairperson N K Singh is currently in session. 

The age-old wisdom is that state government taxes are less “buoyant” (less correlated to economic growth) then Union taxes. To correct this imbalance, a net transfer from the Union to States of 42% of the Union tax resources meets more than one-third of the aggregate state revenue requirements. 

However, if land and water use are taxed appropriately, the presumed imbalance in tax potential between the Union and the state governments will shrink. Also, the 6000 towns and the 0.26 million rural local bodies need to be fiscally empowered to generate their own resources through the levy of property taxes and user charges for public services.

None of the above are short term measures. Consequently, till we are beyond the Covid crisis, sometime in July 2021, our only options are belt-tightening and targeting expenditure very narrowly given the government’s prudent desire to limit recourse to additional public debt.

The Union government’s welfare outreach is aligned with the distress being imposed by Covid on the bottom 40% of households, particularly in rural areas. Enhanced allocations for MGNREGA (work on demand) and the cash transfer programs are the highlights.

Shrink, Consolidate or Repurpose to enhance the efficiency of expenditure

It is in belt-tightening that the government has yet to find the mind space to trim down the administrative fat in central schemes which account for Rs 3.4 trillion or slightly more than 10% of its total expenditure and in its outlay on establishment expenditure of Rs 6 trillion which accounts for 20% of its total expenditure.

Pain needs to be visibly shared before it is accepted as a necessary sacrifice by all. But shedding administrative costs comes with enormous resistance and possible loss of political capital. Far better then to start looking at widening the tax base; simplifying the tax structure and optimizing the tax incidence to preserve the incentive to be tax compliant. 

Doing all these together enhances the disruption. But it also spreads the pain widely and makes the economy more resilient, thereby reducing the potential for arrhythmia in our fiscal affairs.

Also available at TOI Blogs July 2, 2020

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