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Mainstream, Vol XLVIII, No 1, December 26, 2009 - Annual Number 2009

Efforts Towards Fiscal Consolidation: A Critical Review

Saturday 26 December 2009, by Anil Kumar Jain

Introduction

For a sustainable fiscal policy it is essential that the fiscal consolidation process is not only facilitated but also strengthened by concerted efforts to boost revenue flows to meet the growing expenditure requirements. In empirical literature, two kinds of fiscal consolidation are identified. The first type of fiscal consolidation incorporates adjustments which rely mainly on expenditure reduction through cuts in revenue expenditure and, if possible, also in rates and types of taxes. In this type of adjustment, the composition of spending cuts is an important consideration due to its impact on the formation of expectations of the current and impending measures and the credibility of the reform process.

The second type of fiscal consolidation incorporates measures which rely mainly on broadbased tax changes, without affecting public expenditure. However, the type of fiscal consolidation measures that should be followed in any economy would depend upon a clear understanding of the background of the situation with respect to the indicators of important varieties of deficits. In the Indian case, both the approaches have been followed to control deficits. While it is true that both the Central and State governments have been suffering from the problem of increasing deficits, the problem, of late, is more serious in the case of the Central Government in India. Our object, in this paper, is to confine our attention towards efforts made by the Central/Union Government and make a critical appraisal of the success achieved in controlling deficits. Suggestions would also be made towards controlling increasing deficits so as to achieve fiscal consolidation in future.

Fiscal Scenario in 1990s

By 1990, the situation on the fiscal front had become precarious. The technique of financing capital expenditure out of revenue surpluses till 1978-79 got translated into increasing revenue deficits. The gross fiscal deficit of the Central Government, which is a reflection of the resource gap, increased from 3.1 per cent of the GDP in 1970-71 to 5.8 per cent of the GDP in 1980-81, to a high of 8.5 per cent of the GDP in 1986-87 and was 6.6 per cent of the GDP in 1990-91 (excluding the States’ share against small savings collection—Table 1). Similarly, the revenue surpluses of 0.4 per cent of the GDP in 1970-71 got translated into revenue deficit of 1.4 per cent of the GDP in 1980-81 and to 3.3 per cent of the GDP in 1990-91. Such increases in deficits were unsustainable.

TABLE 1

Measures of Deficit of the Central Government (Rs crores)
Year Gross Fiscal Deficit* Revenue Deficit Gross Primary Deficit*
1990-91 37,606 (6.61) 18,561 (3.26) 16,108 (2.83)
1991-92 30,844 (4.72) 16,261 (2.49) 4248 (0.65)
1992-93 35,909 (4.80) 18,575 (2.48) 4834 (0.65)
1993-94 55,257 (6.43) 32,716 (3.81) 18,516 (2.16)
1994-95 48,030 (4.74) 31,029 (3.06) 3970 (0.39)
1995-96 50,253 (4.23) 29,731 (2.50) 208 (0.02)
1996-97 56,242 (4.11) 32,654 (2.39) (-)3236 (-0.24)
1997-98 73,204 (4.81) 46,449 (3.05) 7567 (0.50)
1998-99 89,560 (5.14) 66,976 (3.85) 11,678 (0.67)
1999-00 1,04,717 (5.36) 67,596 (3.46) 14,468 (0.74)
2000-01 1,18,816 (5.65) 85,234 (4.05) 19,502 (0.93)
2001-02 1,40,955 (6.19) 1,00,162 (4.39) 33,495 (1.47)
2002-03 1,45,072 (5.91) 1,07,879 (4.39) 27,268 (1.11)
2003-04 1,23,272 (4.48) 98,262 (3.55) (-)816 (-0.03)
2004-05 1,25,794 (3.99) 78,338 (2.51) (-)1140 (-0.04)
2005-06 1,46,435 (4.09) 92,300 (2.59) 13,805 (0.39)
2006-07 1,42,573 (3.50) 80,222 (1.90) (-)7699 (-0.2)
2007-08 1,26,912 (2.70) 52,559 (1.10) (-)44,118 (-0.9)
2008-09 (RE) 3,26,515 (6.0) 2,41,273 (4.40) 1,33,821 (2.5)
2009-10 (BE) 4,00,996 (6.8) 2,82,735 (4.8) 1,75,485 (3.0)

*The figures are excluding the States’ share against small savings collection.

**The ratios of GDP of the previous years have undergone changes as new series of GDP at current market prices have been released by the CSO from time to time.

Note: 1. Figures in parenthesis are percentage to the GDP at current market prices.

2. Negative sign indicates surplus.

Source: Ministry of Finance, Department of Economic Affairs, Economic Division, Indian Public FinanceStatistics 2007-08, pp. 41-43.

Efforts at Fiscal Consolidation

When the Congress Government assumed office on June 21, 1991, the main stance of fiscal policy under the New Economic Policy (NEP) was, among other things, to reduce fiscal and other deficits. All through the period 1991-2008, there has been an awareness about the need for fiscal correction. Successive governments have sought to deal with the problem of deficits and carried the process of fiscal consolidation. Such efforts have been in the areas of tax reforms—both in direct and indirect taxes, expenditure manage-ment, curbing government debt and interest payments, reducing subsidies, raising resources through disinvestment and providing for an institutional framework for responsible fiscal policy.

(i) Tax Reforms

Tax reforms in the post-1991 era have been largely guided by the recommendations of the Tax Reforms Committee (Chairman—Dr Raja J. Chelliah), the Advisory Group on Tax Policy and Tax Administration for the Tenth Plan (Chairman —Parthasarathi Shome) and the Report of the Task Force on Direct and Indirect Taxes (Chairman —Vijay Kelkar). During the post-1991 period, changes in India’s tax system have been geared to move towards a tax structure which is simple, relies on moderate rates with a wider base and better enforcement, serves the objectives of equity and provides the incentives and signals consistent with developing an internationally competitive and dynamic economy. The major thrust of indirect tax reforms has been to lower the level of duties and simplify and rationalise the structure of customs and excise duties.

The implementation of the aforesaid objectives in direct taxes has been reflected in the gradual increase in the threshold (exemption) limit of personal income tax from Rs 22,000 in 1991-92 to Rs 50,000 in 1998-99 to Rs 1,00,000 in 2005-06 and further to Rs 1,60,000 for the financial year 2009-10 (Assessment Year 2010-2011). To help senior citizens (65 years and above), the system of additional tax rebate introduced in 2002-03 has culminated into a higher exemption limit of Rs 1,85,000 in 2005-06 and further to Rs 2,40,000 for the financial year 2009-10. Similarly, to encourage working women, the system of enhanced standard deduction, introduced by the Finance Act, 1992, was replaced by a tax rebate by the Finance Act, 2000 and a higher exemption limit by the Finance Act, 2005 which has been further increased to Rs 1,90,000 by the Finance Bill, 2009.

After the recommendation of the Wanchoo Committee (1971), the Indian Government has tried to reduce the number of slabs, as also the rates in respect of personal income tax. The number of slabs which stood at four at the time of introduction of reforms has been reduced to three and the highest rate brought down from 50 per cent in 1990-91 to 40 per cent in 1991-92 and further to 30 per cent in 1997-98. By the Finance Bill, 2009, the basic rate of 10 per cent is applicable on incomes between Rs 1.60 lakh to Rs 3 lakhs, 20 per cent for incomes between Rs 3 lakhs to Rs 5 lakhs and 30 per cent for incomes above Rs 5 lakhs from the assessment year 2010-11. Surcharge at the rate of 2.5 per cent was applicable for incomes above Rs 10 lakhs which has now been abolished. In addition, a taxpayer has to pay a two per cent Education Cess and an additional one per cent Secondary and Higher Education Cess from the assessment year 2008-09. In the case of companies, which are always subject to a flat rate, the rate of income tax, which was 50 per cent for the assessment year 1990-91, was reduced to 45 per cent from the assessment year 1992-93, to 40 per cent from the assessment year 1995-96, to 35 per cent from the assessment year 1998-99, and to 30 per cent from the assessment year 2006-07. In addition, a 10 per cent surcharge is payable by a domestic company having total income exceeding Rs 1 crore and 2.5 per cent by every company other than a domestic company. Further, such companies are liable to pay Education Cess at the rate of two per cent and Secondary and Higher Education Cess at the rate of one per cent, applicable to all other taxpayers.

Measures to widen the tax base have comprised introduction of a presumptive scheme of computation of income for persons engaged in retail trade, introduction of an Estimated Income Method of assessment for certain categories of taxpayers, introduction of a Minimum Alternate Tax for companies, enlargement of the scope of deduction at source, obligatory filing of income tax return based on certain economic indicators (one-by-six scheme), providing for non-filing of return of income, compulsory mention of bank account number in income tax return, introduction of a fringe benefit tax etc. The gift tax was abolished from October 1, 1998 and with effect from April 1, 1993, the wealth tax is payable at a flat rate of one per cent on wealth exceeding Rs 15 lakhs in respect of net wealth (excluding productive wealth). The exemption limit has now been raised to Rs 30 lakhs in view of the inflationary trends. In addition, the tax treatment of capital gains has been modified so as to exempt long-term capital gains from (provided STT has been paid on it) and tax short-term capital gains at the rate of 15 per cent (from the assessment year 2009-10). Certain measures have also been taken to prevent revenue leakages/tax evasion and make the tax administration more efficient.

In the field of custom duties, import duties were inordinately high in India and in several cases they were more than 300 per cent prior to the 1991 reform. A phased reduction in the peak rate of customs duty has been undertaken since 1991 so as to reduce it to 110 per cent in 1992-93, 40 per cent in 1997-98 and 15 per cent in 2005-06, excluding agriculture and dairy products. The peak rate of customs duty on non-agricultural products was reduced from 15 per cent to 12.5 per cent in 2006-07 and to 10 per cent in 2007-08.

In the Budget for 1999-2000, 11 major ad-valorem rates of excise duty existed; these were reduced to three, namely, a Central rate of 16 per cent, a merit rate of eight per cent and a demerit rate of 24 per cent. In the Budget for 2001-02, a single rate of 16 per cent CENVAT was introduced also in respect of special excise duties and in the Budget for 2008-09, the general CENVAT rate on all goods has been reduced from 16 per cent to 14 per cent to provide stimulus to the manufacturing sector.

To broaden the base for domestic indirect taxes, selected services (three) were brought under the ambit of service tax in 1994-95. Subsequently, the number of services subject to service tax was gradually increased to 99 in 2006-07. Eight more services were added in 2007-08 and an additional four in 2008-09. The rate of service tax has also been gradually increased from eight per cent to 12 per cent in 2006-07; however, the rate of service tax has been reduced to 10 per cent in 2009. In addition, an Education Cess and a Higher Education Cess are also payable.

As a consequence of the measures undertaken in the area of tax reforms, the gross tax revenue of the Central Government increased from Rs 57,576 crores in 1990-91 to Rs 1,88,603 crores in 2000-01 and to Rs 6,27,949 crores in 2008-09 (RE)—direct tax receipts from Rs 11,024 crores to Rs 68,306 crores and to Rs 3,45,000 crores and indirect tax receipts from Rs 45,158 crores to Rs 1,16,125 crores and to Rs 2,81,359 crores, respectively. For the fiscal year 2009-10, gross tax receipts have been budgeted at Rs 6,41,079 crores—direct tax receipts at Rs 3,70,000 crores (57.7 per cent) and indirect tax receipts at Rs 2,71,079 crores (42.3 per cent). An important structural change which has occurred during the post-1991 era is that the share of direct taxes in total tax revenue, which was only 19.1 per cent in 1990-91, increased to 36.2 per cent in 2000-01 and further to 54.9 per cent in 2008-09 (RE). Consequently, the share of indirect taxes has declined from 78.4 per cent in 1990-91 to 45.1 per cent in 2008-09 (RE)—of customs duty from 35.6 per cent to 17.19 per cent and of union excise duty from 42.6 per cent to 17.25 per cent. For the financial year 2009-10, these shares have been budgeted at 15.28 per cent and 16.60 per cent respectively. However, the share of service tax in the total tax revenue has gone up from 1.7 per cent in 1999-2000 to 10.35 per cent in 2008-09 (RE) and is placed at 10.14 per cent during 2009-10 (BE).

But two disquieting features in receipts need to be noted. First, despite increase in gross tax collections, the tax/GDP ratio declined from 10.31 per cent in 1991-92 to 8.80 in 2002-03. It is only recently that this ratio has improved to 11.5 per cent in 2008-09. Second, in most of the years, the actual total revenue receipts, as also tax receipts have fallen short of Budget estimates. For example, in thirteen out of eighteen years between 1990-91 to 2007-08, the actual total revenue receipts (net to Centre) have fallen short of Budget estimates and in ten of these eighteen years, the actual revenue expenditure has exceeded the Budget estimates. Similarly, in nine out of twelve years between 1996-97 to 2008-09 the total direct tax collections have fallen short of the Budget expectations, despite the considerably high growth rate of collection of these taxes. Consequently, the revenue deficit tended to increase. And during 2008-09, the revenue deficit turned out to be 70 per cent of the gross fiscal deficit. A serious problem with revenue deficit is that it does not result in creation of any assets. It merely adds to the interest and repayment burden without creating a wherewithal from where the date could be served.

(ii) Expenditure Management

With the passage of time, the government expenditure has tilted in favour of the revenue expenditure and capital expenditure had to bear the brunt. While the total revenue expenditure of the Central Government in 1990-91 was Rs 73,516 crores, it increased to Rs 2,77,839 crores in 2000-01, to Rs 8,03,446 crores in 2008-09 (RE) and is placed at Rs 8,97,232 crores in 2009-10 (BE)—to become 12.20 times during the last 19 years; capital expenditure has increased from Rs 27,327 crores in 1990-91 to Rs 47,753 crores in 2000-01 and to Rs 97,507 crores only in 2008-09 (RE)—to become 3.57 times. Capital expenditure has been proposed at Rs 1,23,606 crores for the fiscal year 2009-10. Further, the composition of the Central Government expenditure has acquired rigidity on account of pre-committed heads of expenditure like interest payments, defence, subsidies, pay and allowances and non-plan grants to States. For example, interest payments have gone up from Rs 21,498 crores in 1990-91 to Rs 1,92,694 crores in 2008-09 (RE), defence expenditure from Rs 15,426 crores to Rs 1,14,600 crores, explicit subsidies from Rs 12,158 crores to Rs 1,29,243 crores during the same period. Pay and allowances of the Central Government employees have gone up from Rs 15,209 crores in 1993-94 to Rs 46,379 crores in 2007-08 (BE). Similarly, non-Plan grants to States and Union Territories have increased from Rs 3982 crores in 1990-91 to Rs 14,717 crores in 2000-01 and is placed at Rs 37,255 crores in 2008-09 (RE). Consequently, these items constitute nearly 90 per cent of the non-Plan expenditure and about 70 per cent of the total expenditure.

The most important step taken in the direction of expenditure restructuring and reforms was the appointment of the Expenditure Reforms Commission (ERC) on February 28, 2000 under the chairmanship of K.P. Geetakrishnan. The government has taken several steps to control non-developmental expenditure in the light of the recommendations of the ERC. In order to reduce the burden of interest payments, the government signalled a rate cut in the interest on small savings, public provident fund, post-office monthly income account, national savings scheme, Kisan Vikas Patra etc.

Following a softening of the interest rate regime, the government initiated the debt restructuring process through pre-payment of external debt, buy-back of loans from banks contracted under the high interest rate regime and the Debt-Swap Scheme with the State governments. In respect of domestic debt, the government introduced the Debt Buy-back Scheme under which the Central Government offered to buy-back high interest loans from banks on voluntary basis. This scheme has enabled the banks to improve their liquidity position by encashing premium for making provisions for their NPAs. With regard to external debt, the government has effected pre-mature repayment of high-cost currency pool loans of the World Bank and Asian Development Bank. Despite various measures, the total internal liabilities (internal debt plus other liabilities) of the Central Government have increased from Rs 2,83,033 crores in 1990-91 to Rs 26,33,197 crores in 2007-08 (BE). Similarly, external debt has also gone up from Rs 1,63,001 crores at the end of March 1991 to Rs 8,84,516 crores at the end of March 2008 (QE).

Disinvestment of equity in the public sector undertakings (PSUs) was started in December 1991 in order to earmark a part of the proceeds towards debt reduction and reduce fiscal deficit. A Disinvestment Commission was set up for the purpose in 1991-92 and a Department of Disinvestment (DOD) was created which was later converted into a Ministry. The Disinvest-ment Commission was reconstituted in July 2001. Between 1991-92 to 2007-08, the govern-ment has realised Rs 51,608.58 crores (against the target of Rs 96,800 crores) from sale in respect of 136 PSUs.

Increasing subsidies have played an important role in increasing deficits in India. One of the important methods of reducing the fiscal stress in India is to target reduction in non-merit subsidies. During 2000-01, the ERC recommended rationalisation of fertiliser subsidy to downsize the government revenue expenditure. However, it is unfortunate to note that the government has failed in reducing the subsidy burden. Instead, food subsidy has increased from Rs 2450 crores in 1990-91 to Rs 43,627 crores in 2008-09 (RE) and fertiliser subsidy from Rs 4389 crores to Rs 75,849 crores during the same period. The share of total explicit subsidies in fiscal deficit has gone up from 33.33 per cent in 1990-91 to 53.59 per cent in 2008-09 (BE) and is placed at 39.58 per cent in 2008-09 (RE) resulting in a sharp increase in the fiscal deficit during the year 2008-09.

Curbing defence expenditure has also been included as a measure of controlling the increasing fiscal deficit. But on account of the unexpected conflict in Kargil and continued tension on the border, it has not been possible for the government to reduce defence expenditure which has tended to increase with the passage of time. Such reduction in defence expenditure is also not desirable for reasons of national security.

Government departments, including Railways and Posts, have long been overmanned. There are also too many government departments. Dr Raja J. Chelliah [Towards Sustainable Growth, p. 118] emphasised the need for ways to deal with surplus staff. Later, the ERC also recommended several measures. The Fifth Pay Commission had suggested that a 30 per cent reduction in government staff should be achieved over time. Nevertheless, much has not been achieved on this front also. The implementation of the recommendations of the Sixth Pay Commission will certainly add to additional pressures.

(iii) Institutional Framework for a Responsible Fiscal Policy

Managing fiscal discipline in the midst of competitive demands on public resources and tax expenditures vis-à-vis varied and often conflicting expectations of stakeholders is a very complex exercise. The perception in India has been that the Budget figures are not at all what they appear on paper and such figures are subject to considerable manipulation. In the late nineties, considerable debate took place over the need for fiscal transparency and fiscal responsibility. Accordingly, a Committee, under the chairmanship of E.A.S. Sharma, was set up in 2000 to recommend a draft legislation on fiscal responsibility. Later, the Ahluwalia Committee (2001) also emphasised the need for improvement in budgetary practices and recommended that the Budget should provide forecasts of key fiscal magnitudes. Hence, the Fiscal Responsibility and Budget Management Bill was introduced in Parliament in December 2000. As the Bill was referred to the parliamentary Standing Committee, it could be enacted only on August 23, 2003 and came into force from July 5, 2004. This Act stipulates appropriate measures by the Central Government to reduce the fiscal deficit and eliminate the revenue deficit by March 31, 2008 and thereafter build up adequate revenue surplus. The Act also requires the government to place before Parliament the outcome of a quarterly review of trends in receipts and expenditure in relation to the Budget estimates. The objective is to enhance transparency in the Central Government’s fiscal operations. The FRBM Rules were framed in 2004 under which annual targets for phased reduction in key deficit indicators are laid down. A Task Force, under the chairmanship of Vijay Kelkar, was also set up to draw the medium-term framework for fiscal policy to achieve the objectives set out in the FRBM Act, 2003. This Task Force has proposed several measures towards revenue augmentation and revenue expenditure reforms so as to counter-balance the contractionary effects of fiscal consolidation.

Evaluation of Fiscal Consolidation Measures and the Fiscal Scenario

It is claimed by the government that the adoption of various measures has resulted in reducing the deficit ratios to the GDP in respect of the fiscal deficit, revenue deficit and primary deficit. For example, the GFD/GDP ratio (excluding the States’ share in small savings collection), has declined from 6.61 per cent in 1990-91 to 5.65 per cent in 2000-01 and further to 2.50 per cent in 2008-09 (BE). However, due to fiscal accommo-dation in order to counter the negative fall-out of the global slowdown on the Indian economy which was evidenced in the form of tax relief and increased expenditure, the GFD/GDP ratio increased to six per cent during 2008-09 (RE) and is placed at 6.8 per cent in 2009-10 (BE). Similarly, the revenue deficit was expected to decline from 3.26 per cent of the GDP in 1990-91 to one per cent of the GDP in 2008-09 (BE) after reaching a peak of 4.39 per cent of the GDP in 2001-02. However, the revised RD/GDP ratio has turned out to be 4.4 per cent during 2008-09 (RE) and is placed at 4.8 per cent in 2009-10 (BE). Further, the gross primary deficit, which was 2.83 per cent of GDP in 1990-91, was placed at a gross primary surplus of 1.1 per cent of the GDP during 2008-09 (BE) but it turned out to be a gross primary deficit of 2.5 per cent of the GDP.

While presenting his Budget for 2008-09, the Finance Minister, P. Chidambaram, observed:

I am happy to report that the revenue deficit for the current year will be 1.4 per cent (against BE of 1.5 per cent and fiscal deficit will be 3.1 per cent (against BE of 3.3 per cent). Further progress will be made in 2008-09.… The fiscal deficit is estimated at … 2.5 per cent of GDP. Honourable Members will note that not only will I achieve the target for fiscal deficit under the FRBM Act, I have also left for myself some headroom. In case of revenue deficit, I will meet the target of annual reduction of 0.5 per cent.

However, all such hopes have been belied under the umbrella of the international financial meltdown under whose huge impact tax receipts fell due to reduction in the CENVAT rate from 14 per cent to 10 per cent and then to eight per cent and service tax rate by two per cent from 12 per cent to 10 per cent as the non-Plan expenditure increased sharply. Consequently, the Finance Minister, Pranab Mukherjee, observed in his Budget speech for 2009-10:

The revenue deficit as a percentage of GDP is projected at 4.8 per cent as compared to one per cent in BE 2008-09 and 4.6 per cent as per provisional accounts of 2008-09. The fiscal deficit as a percentage of the GDP is projected at 6.8 per cent compared to 2.5 per cent in BE 2008-09 and 6.2 per cent as per provisional accounts 2008-09. The level of deficit is a matter of concern and Government will address this issue in right earnest to come back to the path of fiscal consolidation at the earliest.

However, if the past is any guide when there had been great divergence between Budget estimates and the final outcome, it is extremely doubtful if the Budget figures of fiscal deficit during 2009-10 will be maintained because fiscal deficit at Rs 54,100 crores in April 2009 has already touched 13.2 per cent of the projected figure for the entire year.

However, a closer look at the historical trends of deficits and finer prints contained in the Budgets would reveal that the Finance Minister has presented a more optimistic picture and the actual picture is much less rosy. Two important methods of window-dressing need to be noted. First, since the 1999-2000 figures are shown as net of the States’ share in small savings. For example, including the States’ share in small savings, the GFD was Rs 44,632 crores in 1990-91 as against the GFD of Rs 37,606 crores after excluding the States’ share—a difference of Rs 7026 crores. Similarly, during 1998-99, the GFD (including the States’ share in small savings collection) was Rs 1,13,349 crores, as against Rs 89,560 crores—a difference of Rs 23,789 crores. Excluding the States’ share in small savings has resulted in presenting a more rosy picture in terms of decline in absolute figures as also ratio. Second, off-Budget liabilities are not shown on the Budget and thus reduce the quantum of deficit. Total expenditures on subsidies in nine out of 10 years during 1999-2000 to 2008-09 have exceeded the Budget estimates. This discrepancy has been maximum during the year 2008-09—as per the revised estimates for 2008-09, fertiliser subsidies amounted to Rs 75,849 crores against the Budget estimates of Rs 30,986 crores (excess of Rs 44,863 crores) and food subsidies amounted to Rs 43,627 crores against the budgeted figure of Rs 32,667 crores (an excess of Rs 10,960 crores). Including oil bonds worth Rs 75,667 crores and fertiliser bonds worth Rs 20,000 crores, the total subsidies bill for 2008-09 amounted to Rs 2,19,582 crores (roughly three times the budgeted figures). Such large and growing off-Budget liabilities are a matter of concern but such items of expenditure are kept outside the Budget on account of the keenness to adhere to the targets in the FRBM Act. The former Governor of the RBI, Y.V Reddy, also accepted that the government’s fiscal deficit does not reflect the underlying pressures and that the country’s fiscal deficit as a percentage of the GDP continues to be among the highest in the world. (Reported in The Economic Times, dated May 27, 2008)

The bonds issued to oil companies to provide for losses due to under-recoveries on the selling price of petroleum products, bonds issued to the Food Corporation of India and fertiliser companies etc., although a liability of the government, is not counted for calculating deficits of the year in question. According to the CAG, the revenue deficit in 2006-07 was Rs 1,32,847 crores and fiscal deficit Rs 1,82,934 crores after counting the off-Budget subsidies and bonds (as against RD of Rs 80,222 crores and FD of Rs 1,42,573 crores shown in official documents). (The Economic Times, February 26, 2008) According to the 2008-09 economic outlook released by the PM’s EAC, these off-Budget subsidies could amount to five per cent of the GDP, over and above the budgeted fiscal deficit of 2.5 per cent.

A review of the progress on the fiscal front during 2008-09 reveals that the government’s fiscal deficit had touched 244.9 per cent of the fiscal target while revenue deficit had exceeded the target by 337.2 per cent. Nevertheless, expenditure reforms at the Centre’s level should ensure that expenditure correction should not compromise with the quality of expenditure. There is need for improving the quality of expen-diture through expenditure adequacy (adequate provision for providing public services), effective-ness (assessment of performance) and efficiency of expenditure use. In the backdrop of committed non-development expenditure (comprising of interest payments, wages and salaries, defence, subsidies etc.) there is need to focus on develop-ment expenditure which is ‘growth oriented’. This would necessitate detailed expenditure planning, strict prior funding norms and minimum delays and waste in expenditures. The impact of this huge additional spending will be that government borrowing will increase, push up interest rates, pre-empt savings and crowd out the private sector. Consequently, the damage on account of the higher fiscal deficit will be more permanent.

The Way Out

The correction of fiscal imbalance should focus on the root cause of the disequilibrium—the government not able to balance its consumption outlays with revenue. The plan for restructuring should rely both on augmenting revenues and restructuring expenditures. However, restruc-turing of public expenditure seems to be very difficult under the present circumstances because revenue expenditure accounts for 89.2 per cent of the Centre’s aggregate expenditure during 2008-09 (RE) and only 10.8 per cent would be capital expenditure for investment purposes. Further, interest payments, defence expenditure, subsidies, pensions and transfers to States pre-empt nearly total revenue receipts of the Central Government. In view of the recent increase in expenditure on off-Budget items and implementation of the Sixth Pay Commission’s recommendations, compression of expenditure is very difficult. Hence, significant fiscal improve-ment will hinge increasingly on improvement in revenue collection through direct and indirect taxes.

In the field of indirect taxes, there has been a relatively slower growth of tax receipts on account of bringing down the duty rates to international standards. Accordingly, gross receipts from customs have increased from Rs 20,644 crores in 1990-91 to Rs 1,08,359 crores in the revised estimates for 2008-09 (5.24 times), gross receipts from Union excise duties have gone up from Rs 24,514 crores to Rs 1,08,359 crores (4.42 times) during the same period. Nevertheless, there is need for larger tax bases and low rates, limited rate categories, absence of tax cascading, minimum exemptions and absence of tax barriers in inter-State trade. Where tax related decisions of the Central Government affect the tax bases of the State governments and vice-versa, there is need for vertical coordination in using common tax fields. There should be uniform VAT in all the States and tax-related barriers should be removed. The ultimate remedy lies in adopting a common Goods and Service Tax (GST)—a Central GST and a State GST. In the field of indirect taxes, receipts from service tax have great potential because its receipts have already grown from Rs 407 crores in 1994-95 to Rs 65,000 crores in 2008-09 (RE) and the service sector contributes nearly 55 per cent of the GDP in India. There is need to expand the base of service tax by bringing new services into the tax net. Certain problems in taxation of services such as a large number of service providers being in the informal sector, the problem of identification, assessment and enforcement, and variations in standards of assessment need to be tackled through concerted efforts.

In the field of direct taxes, India needs to have a tax system which is simple, has a wider base with moderate rates, discourages avoidance and evasion, is well administered and above all promotes economic efficiency, growth and equity. Equal treatment of equals requires a careful selection of adequate index of ability in such a manner that proportionately larger burden is placed on the shoulders of the better-off sections of the society. The exemption limit / threshold limit should not be increased further. Together with simplicity, the tax system needs to be transparent and should have a moderate degree of progression. While choosing an appropriate degree of progression, aspects of economic incentives, available administrative ability and general attitude of the taxpaying population must be kept in view. Some important desirable steps in the field of direct taxes should include stability in tax laws (including incentive provisions), the taxpayers’ comprehensive education programme, regular and systematic surveys, introduction of consolidated return of direct taxes, inclusion of agricultural income under the ambit of taxation through appropriate legislation, coordination among taxing departments, emphasis on ‘accountability’ and switch over to ‘family’ as the unit of assessment. Some of these measures might appear to be ambitious in the present context, but we think that only hard decisions are going to be fruitful in the long run and populist measures are not going to work.

There is an urgent need to check the malady of tax evasion and attack corruption by strengthening the anti-corruption institutions. The government should identify a few big corrupt figures and tax evaders and they should be punished and convicted. The anti-evasion strategy should emphasise greater involvement of citizens who are the most fertile source of information about avenues of evasion and corruption. However, the ultimate success in this regard would depend upon the adequacy of measures in their comprehensiveness, scope and powers and level of commitment of the political leadership to the goals of minimising corruption.

The success of any tax system does not depend only on how it has been formulated but also upon how it is administered. This, in turn, depends, among other things, on simplified procedures and smoother functioning of the administrative processes Laws which define fiscal liabilities should be precise and unambiguous. During the post-reform period, despite repeated pronouncements towards improving the tax administration, hardly anything has been done in this regard. It would be evident from Table 2 that arrears of income tax assessment (including corporation tax) increased from 12,82,202 cases at the end of March 1991 to 1,65,99,206 cases at the end of March 2002. Thereafter, following some respite in 2003, they have again gone up to 1,07,32,289 cases at the end of March 2007. What is more worrisome is the fact that there has been a progressive decline in the completion of assessments from 89.87 per cent in 2002-03 to 66.44 per cent in 2006-07, resulting in a steady increase in pendency over the last five years. Similarly, gross arrears of collection (income tax plus corporation tax) have increased from Rs 6695 crores at the end of March 1991 to Rs 90,177 crores at the end of March 2002 and further to Rs 1,17,130 crores at the end of March 2007. Further, the pendency of appeals with Commissioners of Income Tax (Appeals), while showing a fluctuating trend, stood at 1,07,841 cases at the end of March 2007. Such a grim scenario in respect of arrears of assessments and collection and pendency of appeals is a pointer in the direction of the efforts required. The problem of arrears of collection in respect of taxes on commodities and services, though not as serious as in respect of income taxes, is nonetheless grave because during 2007-08 these arrears were Rs 23,623 crores. If such arrears of collection are realised through concerted efforts, the malady of increasing deficits would be met to a considerable extent.

TABLE-2

Position in respect of Arrears (Income Tax, including Corporate Tax)
As on 31st March Arrears of Assessment (Number) Gross Arrears of Collection (Rs Crores) Pendency of Appeals with CIT (Appeals)(Number)
1991 12,82,202 6695 2,19,969
1992 13,21,391 8461 2,46,449
1993 14,50,200 9211 2,22,366
1994 15,40,729 10,780 2,66,682
1995 24,12,444 22,699 -
1996 23,21,673 28,970 -
1997 16,62,180 33,585 2,15,313
1998 25,84,306 41,230 -
1999 98,76,147 44,143 2,14,996
2000 1,30,41,520 52,970 1,89,601
2001 1,25,47,632 56,431 1,71,969
2002 1,65,99,206 90,177 1,55,861
2003 38,29,250 69,606 1,01,223
2004 57,88,771 89,279 82,146
2005 60,33,493 1,24,184 1,56,049
2006 1,03,66,464 1,04,628 64,125
2007 1,07,32,289 1,17,130 1,07,841

Source: Report of the Comptroller and Auditor General of India, Union Government (Direct Taxes)—various years.

Conclusion

Therefore, any programme of fiscal consolidation of the Union Government through taxes must include reforms in the administration of taxes because an excellent and ideally just system, if incapable of enforcement, leads not only to public irritation but also tends to defeat its own aim. While the taxpayers should change their attitudes towards their tax obligations, the tax administrators must ensure that no undue harrassment is caused to the taxpayers. There must be a proactive and friendly approach adopted in the process of assessment and collection. Tax officials must project the image of facilitators and not as a threat to the tax- paying public. While tax evaders must be dealt with strongly, the law-abiding taxpayers must receive desired help from the administrative personnel. The improvement in tax adminis-tration and use of information technology should help greatly in curbing the menace of tax evasion and in enhancement of tax revenues. The success would, however, ultimately depend upon a strong political will and a concerted and committed political leadership. n

REFERENCES

1. Dreze, Jean and Amartya Sen (1995), India: Economic Development and Social Opportunity, New York, Oxford University Press.

2. Government of India, Economic Survey (Various Issues), New Delhi.

3. Government of India, Union Budget, 2009-10.

4. Jain, Anil Kumar (2008), “Restructuring Union Finance: Raising Tax/GDP Ratio†, in Ajit Kumar Singh (ed.), Twelfth Finance Commission’s Recommendations and their Implication for State Finances, New Delhi, APH Publication, pp. 230-242.

5. Jain, Anil Kumar and Parul Gupta (2007), “Direct Tax Proposals in the Union Budget 2007-08: What the Finance Ministry should not have done?†, Current Tax Reporter, 208 (VI), pp. 124 – 131.

6. Jain, Anil Kumar and Parul Jain (2007), Reforms in Direct Taxes through Union Budgets: A Commentary, RBSA Publishers, Jaipur.

7. Jain, Anil Kumar (2007), “Fiscal Prudence: Has it really been achieved?†, Mainstream, XLV(14), pp. 5-7.

8. Jain, Anil Kumar (2006), “Income Tax Administration needs to be given top Priority in the forthcoming Budget for 2006-07†, Current Tax Reporter, 200 (IV), pp. 255-66.

9. Jain, Anil Kumar, (2006), “Income Tax Reforms in India after 1991†, Current Tax Reporter, 200 (I), pp. 20-43.

10. Jain, Anil Kumar (2004) “Economic Reforms and their Impact on Government Finances:, Artha Beekshan, 13(2), pp. 17-24.

11. Jain, Anil Kumar (2003), “Fiscal Consolidation in India: A critical Review and Unfinished Agenda†, Research Journal Social Sciences, 11(1), pp. 64-79.

12. Jain, Anil Kumar (2001), Direct Taxation in India: Some Aspects, RBSA Publication, Jaipur.

13. Jain, Anil Kumar (1994), Fiscal Deficits and Resources Mobilisation†, Finance India, Vol. VIII (No. 3), Pp. 609-16.

14. Jain, Anil Kumar (1983), Some Aspects of Income Tax Administration in India, Uppal Publishing House, New Delhi.

15. Jain, Anil Kumar (1975), Taxation of Income in India, Macmillan Company of India Ltd, New Delhi.

16. Reserve Bank of India, Annual Reports (Various Issues), Mumbai.

17. Rangarajan, C., D.K. Srivastava (2005), “Fiscal Deficits and Government Debt in India: Implications for Growth and Stablisation†, NIPFP, New Delhi, Working Paper 35.

18. Srinivasan, T.N. (2000), Eight Lectures on India’s Economic Reforms, Oxford University Press, New Delhi.

Dr Anil Kumar Jain is a Professor of Economics and the Dean, Faculty of Social Sciences, Banaras Hindu University, Varanasi.

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